THE CONDUCT OF MONETARY POLICY IN FIJI: POLICY FORMULATION, IMPLEMENTATION AND THE TRANSMISSION MECHANISM Caroline Waqabaca Steve Morling Working Paper 99/01 June 1999 Economics Department Reserve Bank of Fiji Suva Fiji
The views expressed herein are those of the authors and do not necessarily reflect those of the Reserve Bank of Fiji. 1
This paper examines the formulation, implementation and transmission of monetary policy in Fiji. Monetary policy is formulated by the Reserve Bank of Fiji Board on recommendations from an internal Monetary Policy Committee. Monetary Policy is implemented using open market like operations in Reserve Bank securities to influence liquidity levels and to influence short-term money market interest rates. Monetary policy is transmitted to the BankÕs final objective Ð inflation Ð through commercial bank interest rates and through the real economy. The pass through of changes in policy interest rates to other short-term money market rates is quick. The pass through to commercial bank interest rates is slow but complete. This partly reflects the large proportion of longmaturing time deposits in commercial banksÕ funding base which delays the impact of monetary policy changes on banksÕ cost of funds and on lending rates. The transmission to the real sector is relatively strong and broadly in line with other countries. On average, a one percentage point rise in real short-term policy interest rates reduces the growth rate of the economy in the short-run on average by around one-third of one percentage point. The transmission lag is around one year. The transmission from the real sector to inflation is broadly in line with other countries. On average, a one percentage point rise in the output gap is associated with a 0.2 percentage point rise in inflation. However, the
effect is roughly doubled when the indirect transmission through labour costs is included. The transmission lag is around one year. These estimates, while imprecise, show that the transmission of monetary policy in Fiji can be effective, but substantial changes in interest rates are required to influence inflation if it rises too far above acceptable norms. This underscores the need, as has been highlighted in many other countries, for the Reserve Bank to be preemptive in its policy stance, tightening policy at the first sign of inflationary pressures to ensure that inflation stays within acceptable norms. If inflation is allowed to become entrenched, the output costs of bringing inflation back under control are potentially very large.
Under the Reserve Bank Act, the Reserve Bank of Fiji is charged with maintaining price stability, or more generally low inflation. To achieve and maintain low inflation the Reserve Bank conducts monetary policy. The general term monetary policy refers to policies used by a central bank to influence the money supply and/or interest rates. In the past, monetary policy in Fiji was implemented using direct controls on commercial bank lending. The financial system was heavily regulated and the Reserve Bank exercised controls on the quantity of commercial bank lending and on the interest rates at which loans were provided. Interest rates on deposits were also regulated. Central to this approach was control over the quantity of money. Within this framework, the Reserve Bank used changes in reserve requirements of commercial banks to influence the liabilities of the central bank Ð the money base (currency and deposits with the central bank). By changing the money base the central bank was able to influence the broader money and credit aggregates, and its final objective inflation. Today the financial system is deregulated and the Reserve Bank conducts monetary policy using a market-based approach. The Bank conducts open market like operations in its own securities to influence interest rates. Changes in interest rates affect spending and production and...
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