January 8, 2012Dear Sir,I read your editorial regarding Bermuda’s relationship with Britain with great interest. I agree with much of what you said. However, I would disagree most emphatically with the idea that by converting the Bermuda Monetary Authority into a central bank, Bermudian authorities would gain the ability to pursue an active monetary policy. While I’m not conversant with the constitutional arrangements that govern the BMA, I am very conversant with the workings of a central bank, having been employed in a major industrial-country central bank for close to 30 years. The only way a Bermudian central bank could lower Bermuda-dollar interest rates in order to help boost the local economy would be if it were to allow the Bermudian dollar to depreciate, or to reintroduce exchange controls.Given the extent to which the Island is dependent on imports and is a price-taker in international markets, a lower Bermudian dollar would feed one-for-one into higher import prices. With the very large weight of imported goods and services in Bermuda’s consumer price index, retail prices would soar, largely offsetting any gain in competitiveness the Island might temporarily have gained through the depreciation. Moreover, one could subsequently expect upward pressure on Bermudian wages and salaries as workers attempt to maintain their earnings in real terms. A lower Bermudian dollar would also raise the value of foreign-currency liabilities of Bermudians when expressed in local currency. This could have disastrous consequences for anyone, including the Bermuda Government, who was not hedged, and had to service its foreign-currency debts by converting depreciated Bermuda dollar receipts. I would note that should Bermuda introduce a flexible exchange rate, it would be the smallest country in the world to do so by far. Jamaica, one of the smallest nations to have a flexible exchange rate, has a population of 2.7 million, 40 times larger than Bermuda’s. I would add that Jamaica’s experience with a flexible exchange rate has been dreadful; since its introduction in 1968 the Jamaican dollar has fallen from J$0.77 to US$1 to roughly J$87 to US$1 today In other words, the Jamaican dollar has lost virtually all of its value.Foreign exchange controls would theoretically make it possible for Bermuda to maintain its fixed exchange rate while having interest rates lower than they would otherwise be. As Bermuda once had exchange controls, I can’t see how there would be any constitutional impediment to this happening again. In any event, the reintroduction of foreign exchange controls would present its own lengthy list of problems, including the need for a new, large bureaucracy to enforce them. Also, once in place, it is unlikely that Bermudians would readily repatriate their extensive foreign-currency earnings and capital. Moreover, experience has shown that it is very difficult for any country to successfully limit capital outflows for any length of time. The imposition of exchange controls could well lead to tighter domestic monetary conditions rather than easier ones in the long run. This occurred when Bermuda had exchange controls during the 1970s; mortgage money was very limited as banks rationed credit.Should a Bermudian central bank chose to have a flexible exchange rate, what would its policy objective be? Most modern central banks with flexible exchange rates direct policy to achieve a domestic price inflation target of about two percent per year. For a Bermudian central bank to do likewise, it would have to manage the exchange rate very closely to avoid any significant currency depreciation which would pass through to consumer prices. This would imply keeping interest rates roughly where they are right now, possibly even higher as the new currency regime might not be as credible as the current currency board as operated by the BMA today.In conclusion, the conversion of the Bermuda Monetary Authority into a central bank would only provide the illusion of a new policy instrument. In reality, the Island would likely to be worse off not better.JAMES POWELLOttawa, Canada