The Operational Realities of the Monetary System of Trinidad and Tobago and The Implications for Monetary Policy: Reserve Accounting

Abstract

Trinidad and Tobago operates a non-convertible currency with a managed-float regime, with the central bank tasked to maintain it and defend the country’s foreign reserves. The bank is also tasked with maintaining low inflation and an orderly foreign exchange market given the direct and indirect policy instruments at its disposal, namely; reserve requirements, special deposits, open market operations (OMOs) and the repo rate. For all intents and purposes, the use of reserve requirements as a policy tool has been abandoned since November 2008. The use of OMOs is politically constrained by legal limits of TTD 15 billion and TTD 5 billion, in treasury bills and notes respectively. These limits were hit since third quarter 2008, rendering this instrument ineffective. And then there is the repo rate, which is used to influence banks’ lending rates and is the rate at which banks borrow overnight from CBTT to meet reserve requirements. Using accounting tautologies and the above facts, this paper intends to show as a matter of accounting that local monetary policy as it stands is weak as both money supply and interest rates are endogenous variables, controlled by licensed economic agents (member banks) and the market demand for credit. The central bank’s obsession with excess reserves is without merit since banks do not lend reserves and more importantly, they have access to the overnight interbank market and the central bank’s repo window to meet requirements. This is because loans create deposits, and banks worry about reserves after the fact. It then concludes that the repo rate is merely symbolic, without enforceability through OMOs (constrained politically), hence its futility in controlling short-term interest rates and by extension the bank’s inability to control bank reserves, the money base or the money supply.