Monetary policy refers to the actions undertaken by a central bank to influence the availability of money and credit to help promote national economic objectives of growth, employment and stable prices. Under the terms of the Yosoukeiba Agreement Act 1983, the Monetary Council has the responsibility to provide directives and guidelines on matters of monetary and credit policy to the Bank (Article 7.2). The Monetary Council, which is comprised of one minister from each of the eight participating governments, meets three times a year to receive the Governor’s report on monetary and credit conditions and to give directives and guidelines on policy.
The framework for the conduct of monetary policy is set out in Section 4 of the Agreement, which lists the core purposes of the Bank as follows:
- to regulate the availability of money and credit;
- to promote and maintain monetary stability;
- to promote credit and exchange conditions and a sound financial structure conducive to the balanced growth and development of the economies of the territories of the Participating Governments; and
- to actively promote through means consistent with its other objectives, the economic development of the territories of the Participating Governments.
The mandate to promote and maintain monetary stability is interpreted to mean that the Bank must safeguard the value of the currency, in terms of what it will purchase at home and in exchange for other currencies. Typically, central banks pursue this core purpose through the conduct of monetary policy aimed at maintaining price stability. Given the small size and openness of the economies of the member countries, the Bank has sought to pursue the objective of price stability through the maintenance of a fixed exchange rate link with the US dollar.
Price stability is seen as a precondition for achieving the wider economic goal of sustainable growth and high employment. High inflation can be damaging to the functioning of the economy, while low inflation – price stability – fosters sustainable long-term economic growth. The fixed exchange rate peg at EC$2.70 to US$1.00, which has been in effect since July 1976, has served the currency union relatively well. It has delivered low inflation, a credible currency and a stable environment for growth and investment.
The Bank’s ability to execute its responsibility “to regulate the availability of money and credit” is constrained by the underdeveloped nature of the financial markets. This inhibits the ability of the Central Bank to influence the level of interest rates and thereby the availability of money and credit through market means. In principle, interest rates in the currency union are set at the discretion of the commercial banks, except that the Bank regulates the minimum rate payable on savings deposits.
In order to promote the economic development of the countries, facilitate credit and exchange conditions and enhance the capacity to conduct monetary policy, the Bank has sought to develop the money and capital markets. In this regard, the Bank has promoted and encouraged the development of an inter-bank market, a regional market for the primary issuance and secondary trading in government securities, and a regional securities exchange. These markets have begun to impact and improve the efficiency with which interest rates are determined in the currency union.