In the sec­ond note of its re­vised Pub­lic Ed­u­ca­tion Se­ries, the Cen­tral Bank of T&T yes­ter­day ex­plained why its has moved to open-mar­ket op­er­a­tions (OMOs) as the main plank of its strat­e­gy to ad­dress in­fla­tion­ary pres­sures.

In note en­ti­tled 'Tran­si­tion from Di­rect to In­di­rect Mon­e­tary Pol­i­cy In­stru­ments in Trinidad and To­ba­go,' the Cen­tral Bank said OMOs al­low it to buy and sell se­cu­ri­ties (such as gov­ern­ment trea­sury bills) to af­fect the amount of funds fi­nan­cial in­sti­tu­tions are left with to lend out.

If the Cen­tral Bank wish­es to tight­en fi­nan­cial con­di­tions—by mak­ing cred­it more ex­pen­sive, for ex­am­ple—it may sell se­cu­ri­ties, there­by with­draw­ing funds from the fi­nan­cial sys­tem that would oth­er­wise be used to in­crease cred­it.

Con­verse­ly, if the Cen­tral Bank wish­es to slack­en fi­nan­cial con­di­tions, it may buy se­cu­ri­ties from the fi­nan­cial sys­tem there­by adding fund that can be used to in­crease cred­it.

"Sim­ply put, one of the main jobs of all cen­tral banks is to do all in their pow­er to keep the changes in prices (called in­fla­tion) to tol­er­a­ble lev­els in or­der to avoid a rapid ero­sion of pur­chas­ing pow­er. The ba­sis for giv­ing cen­tral banks this re­spon­si­bil­i­ty is the re­al­i­sa­tion that they can mean­ing­ful­ly im­pact fi­nan­cial con­di­tions."

The bank ex­plained that as re­sult it is tasked with ad­just­ing fi­nan­cial con­di­tions to con­trol the pace of spend­ing ac­cord­ing to in­fla­tion­ary pres­sures.

The Cen­tral Bank point­ed out that there are five cat­e­gories of tool it can use to ad­dress in­fla­tion:

* The first is called ‘moral sua­sion’ where­by the Bank talks to fi­nan­cial in­sti­tu­tions to urge them to ad­just their op­er­a­tions in a way that would im­pact con­di­tions in the way that the Cen­tral Bank de­sires;

* The sec­ond in­volves ad­just­ment in the in­ter­est rate at which the Cen­tral Bank lends to fi­nan­cial in­sti­tu­tions, cur­rent­ly called the ‘re­po rate’: in gen­er­al, a rise in the re­po rate will lead banks to them­selves charge high­er in­ter­est rates on loans, which will re­sult in tighter fi­nan­cial con­di­tions and help to low­er in­fla­tion;

* Third, the Cen­tral Bank can mod­i­fy the amount it re­quires fi­nan­cial in­sti­tu­tions to de­posit at the Cen­tral Bank (the ‘re­serve re­quire­ment’): the more fi­nan­cial in­sti­tu­tions have to de­posit at the Cen­tral Bank, the less they have to lend to their cus­tomers;

* Fourth, the Cen­tral Bank can de­tail where and un­der what con­di­tions fi­nan­cial in­sti­tu­tions can lend to cer­tain sec­tors (so called ‘se­lec­tive cred­it con­trols’);

* The fi­nal method is the OMOs

The Cen­tral Bank ex­plained that cat­e­gories 1 and 2 are ba­sic Cen­tral Bank func­tions.

Cat­e­gories 3 and 4 can be char­ac­terised as ‘di­rect’ or ‘blunt’ in­stru­ments of mon­e­tary pol­i­cy as they do not gen­er­al­ly take in­to ac­count the spe­cif­ic cir­cum­stances of in­di­vid­ual fi­nan­cial in­sti­tu­tions. For ex­am­ple, an in­crease in the re­serve re­quire­ment from 5 to 10 per cent of banks’ to­tal de­posits (the gen­er­al­ly used base for the re­serve re­quire­ment) must be ap­plied across-the-board.

"In con­trast, the OMOs in cat­e­go­ry 5 al­low for vol­un­tary par­tic­i­pa­tion of fi­nan­cial in­sti­tu­tions in the pur­chase and sale of se­cu­ri­ties with the Cen­tral Bank. The mar­ket-de­ter­mined na­ture of OMOs has this im­por­tant ben­e­fit, and the Cen­tral Bank of Trinidad and To­ba­go has been pro­gres­sive­ly mov­ing in this di­rec­tion of em­ploy­ing in­di­rect in­stru­ments of mon­e­tary pol­i­cy," ac­cord­ing to the note.

The Cen­tral Bank said it has been con­duct­ing OMOs as a ma­jor pol­i­cy in­stru­ment since 1998, prin­ci­pal­ly via the sale and pur­chase of trea­sury bills and notes to fi­nan­cial in­sti­tu­tions (so called pri­ma­ry deal­ers).