Barbadian governor proposes adopting new policy rate

DeLisle Worrell and other senior central bank staff suggest adopting three-month Treasury bill rate as key policy rate, saying it is more practical for small, open economies

The Central Bank of Barbados should abandon its key policy rate and focus on intervening in the market for government debt, according to its governor DeLisle Worrell.

Worrell and four other senior members of staff – Michelle Doyle-Lowe, Anton Belgrave, Darrin Downes and Kester Guy – have released a working paper calling for a radical change in the central bank's conventional monetary policy framework.

At present, the central bank's main policy tool is the minimum deposit rate; the minimum rate of interest commercial banks must pay on all interest-bearing deposits. The paper finds that has had "little or no impact" on domestic interest rates, and proposes limiting its use to serve simply as a rate floor to "protect the savings of households with modest means".

In its place, the authors propose adopting the three-month Treasury bill rate as the benchmark rate, and intervening in the market to signal the desired direction of interest rates.

The central bank's interest rate policy aims to keep domestic rates in line with comparable interest rates – notably in the US – and avoid a situation where the rates diverge and provide incentives for "destabilising inflows and outflows of capital", which could deplete the central bank's supply of foreign reserves.

This stands in stark contrast to larger economies that tend to target inflation with their interest rate. The authors say this is impractical in a small and open economy such as Barbados, where up to 80% of Barbados's inflation is imported, and beyond the control of a domestic interest rate.

"It has been the experience in Barbados that monetary policy cannot relieve any pressure that might aggravate imported inflation," the authors said.

Instead, the paper says, the interest rate policy should be dictated by the trend in international interest rates, and whether there is a "perceived need" for a temporary inflow of finance to supplement domestic liquidity.

The authors identify the three-month Treasury bill rate as the ideal instrument to tackle both objectives, as it has proved to be inversely proportionate to the levels of liquidity in the domestic economy.

The authors acknowledged a "natural premium" between the US and Barbados Treasury bill rates, which they say is based on "historical differences" and should be accounted for. Equally, the size of the premium is influenced by the extent of liquidity in the domestic financial system, the public-sector borrowing requirement, and the rate of inflation.

Hence the central bank should accept a certain degree of fluctuation, and as such would be unlikely to intervene in the market if the Treasury bill rate was oscillating between 5% bands of the target reference rate.

This would be underpinned by a liquidity forecasting framework, the paper says, following a similar methodology to the one used by the Central Bank of The Gambia and taking into account the government's cashflows and financing operations, the maturity of existing Treasury bills and the liquidity in the banking system.

If the central bank forecast a shortfall between the amount of Treasury bills offered for tender and the 'expected allotment', it would intervene in the market.

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