The story of Goldilocks and the Three Bears is, in part, a search for the solution that is just right—not too hot or not too cold, not too big or not too small.
Last week the Governor of The Central Bank of T&T (CBTT) in presenting the Financial Stability Report for 2017 indicated that: “Monetary policy has been neutral so far, given domestic and international factors, and the pendulum is swinging towards a rate increase.”
The CBTT Governor is highlighting the problem that almost every central banker is trying to solve at this moment. That is the ability to fashion an interest rate pathway that does not result in over tightening of the economy but one that is not too loose that it causes overheating.
Finding that balance is critical for maintaining economic stability and that balance is in essence the Goldilocks Rate—not too high but also not too low but rather just right.
The nuance of this dilemma for T&T is that there has been a level of fiscal tightening in the economy that is unprecedented in our recent economic history. This is due to changes in the levels of government spending and current and proposed changes to the tax regime.
In my view, it is the fiscal tightening more than any other factor that has kept inflation rates low as it has placed a dampening effect on the circulation of money within the economy.
The CBTT has sought to counter the impact on the fiscal side by maintaining its interest rate policy position and keeping the repo rate at 4.75 per cent.
While the CBTT Governor has described it as a neutral rate, in the context of the external factors that I will soon highlight and the fiscal tightening already mentioned the maintenance of the 4.75 per cent repo rate can actually be interpreted as accommodative.
The evidence for this is in the continued growth in credit creation where business loans, consumer credit and mortgage loans increased by 5.4 per cent, 6.8 per cent and 7.8 per cent respectively year on year.
These are significant growth rates coming on top of a very high base and it is clear that economic activity in T&T would have been much lower were it not for these levels of credit creation.
Now we are at the stage where the CBTT is signaling an increase in rates and this change in stance are being driven in part by events external to T&T and outside of our control.
Given the external factors our policy response both on the monetary and fiscal side as well as the timeliness and extent of our response become critical to achieving a path to economic growth and stability.
A key ingredient in getting this right would be having reasonably accurate and timely data upon which to make decisions. The long awaited National Statistical Institute, replacing the Central Statistical Office, and set to be implemented in 2019 would be welcome although we run the risk of it being overdue given the current need.
US Fed Effect
The search for a neutral rate starts at the US Federal Reserve.
On June 13 they raised interest rates by 25 basis points to two per cent. This rate hike was long anticipated and the reports suggest that the US Fed was swayed by a robust rate of economic growth. Further they are suggesting two more rate hikes to the end of the year which is one more than the estimate at the start of the year.
The situation is complicated as there is no real consensus over what constitutes the neutral rate in the US and further there is also a lag in terms of the time it would take for monetary policy to affect the real economy.
More than that the market tends to look at the action of the Central Bank in terms of how it may affect the economy but the reverse is also true where the Central Bank has to react to how the economy is affecting current monetary policy and credit creation.
So, seven rate hikes in the US since the last quarter of 2015 is still finding its way through the length of breadth of the US economy. In the meantime, our Central Bank has not adjusted rates. This is in part why I suggest that our local policy is accommodative rather than neutral.
From here the US market is anticipating a continued gradual trend of interest rate hikes with the additional rate hike in 2018 being offset by one less rate hike in 2020.
Overall through the US Fed would be seeking to get to a three per cent Fed Funds rate in 2020.
Officials suggesting that a new economic downturn would be addressed by fiscal policy more than by monetary policy have tempered recent concerns about the US Fed overshooting and causing a recession.
The problem with this equation is that the US has used quite a lot of fiscal ammunition in their recent tax cut.
In addition the risk of a trade war due to recent policy action may complicate the narrative as this is, by and large, uncharted territory in a post globalisation world.
Here at home the increases in US rates and the holding steady of TT rates has reduced the differential between the return in TT dollars compared to US dollars and increased the incentive to hold US dollars.
You will note recent advertisements about investing your US dollars locally.
The difficulty in accessing US has tempered the equation and investors are unable to readily act on the incentive to hold US dollars because of availability. However that does not in any way address the latent demand for US dollars, which continues to build.
Just like the US, T&T have also used up quite a lot of their fiscal ammunition over the past couple years. As US rates increases the pressure to raise TT rates will increase. If, as expected, government borrowing continues at elevated levels then it means that the Government may see an increased cost of borrowing.
In addition, as government borrows, TT dollar liquidity will decline from the excess liquidity position that has existed for over a decade.
This is where great care is needed. A CBTT repo rate of 4.75 per cent has not really been transmitted though the local economy because of the level of TT dollars built up in the financial system. This is why deposit rates have been so low for over a decade.
However as liquidity continues to decline the CBTT rate will come more into effect. What we have to guard against is the proverbial tipping point.
That is the place where borrowing increases in the lead up to an election, Government spending increases, liquidity in the financial system is reduced, the CBTT has to raise rates because of external factors and all of this combined causes local interest rates to rise which potentially places private sector credit on the margin under stress.
All of this is to say that we need to be very careful from here. The CBTT has sent their signal to the market. That signal must now be factored into everyone’s decision-making process going forward.
Ian Narine can be contacted via email at ian.narine@gmail.co