a note on the trinidad and tobago inflationary experience, 1965-1976

A NOTE ON THE TRINIDAD AND TOBAGO INFLATIONARY EXPERIENCE, 1965-1976Author(s): E.B.A. St. CyrSource: Social and Economic Studies, Vol. 28, No. 3 (SEPTEMBER 1979), pp. 618-627Published by: Sir Arthur Lewis Institute of Social and Economic Studies, University of the WestIndiesStable URL: http://www.jstor.org/stable/27861769 .

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618

A NOTE ON THE TRINIDAD AND TOBAGO INFLATIONARY EXPERIENCE, 1965-1976

By

E.B.A. St. Cyr

INTRODUCTION

Trinidad and Tobago, traditionally a country of stable prices, did not

escape the world-wide inflation of the seventies, with its associated recession, commodity shortages, currency realignments, and oil and payments crises* A number of background structural and institutional features of the economy are

relevant. Independence from British colonial rule was attained in 1962, and with it political hope and rising economic aspirations. By world standards the

economy is small, extremely open to international trade and other influences,

highly dependent on oil and a few export staples, and with wages and salaries

accounting for only a small share of total product.1 The .ending of the oil boom of the fifties and early sixties left the economy sluggish.2 Monetary management came under a newly created Central Bank in 1965, the year in which the In dustrial Stabilisation Act was enacted.3 Since that year there has been a marked increase in the growth of the money supply, and a slowing down in the growth of wage rates to just about the rate of increase in retail prices.4

The period 1965 to 1976, provides rich data on a number of series which can be used to examine alternative hypotheses. Trends in the key variables are summarised in Table 1 :

TABLE 1: Average Annual Growth Rates of Key Variables

1956/65 1965/72 1972/76 1965/76

Index of Retail Prices 2.4 4.6 16.8 9.1 Index of Minimum Wage Rates 8.3 5.1 18.3 10.1 Index of Import Prices exc. Oil - 9.6 26.0 15.0

Money Supply (Ml): Central Bank Data - 13.2 17.9 19.5

Money Supply (Ml): C.S.O. Data 3.0(a) 8.2 29.2 15.8 Money Supply (M2): C.S.O. Data 5.5 (a) 15.0(c) 30.8 19.1 GDP Current Prices 9.4(b) 8.6(c) 29.9 17.1 GDP Constant Prices 8.5(b) 3.8 12.1 7.1

(a) 1960-65 (b) 1956-61 (c) 1966-72



TRINIDAD AND TOBAGO INFLATIONARY EXPERIENCE 619

THE INFLATIONARY PROCESS In a previous study by the author [St. Cyr 9] rough outlines of the in

flationary process in Trinidad and Tobago, within the structuralist framework, were sketched. The literature on this theme, as on inflation in general [Laidler and Parkin 5] , is large but may be traced through Seers [7] to the Latin

American school [Sunkel 10, ECLA 2] and to the monetarist-structuralist debate on the subject. From his study of Chilean inflation, Harberger [3] had concluded that money was a sufficient explanatory variable. Koot [4] however, for the same case, concluded that there was evidence of wage pusho Interestingly, Laidler and Parkin [5] are broadly in support of the view that inflation is a monetarist phenomenon, and while they do not deny the structuralist position regarding Third World countries, conclude that the distinction between perfectly anticipated and imperfectly anticipated inflation was a more useful distinction than that between cost push and demand pull.

The bare outlines of the model to be tested may now be set out. Supply is elastic since the economy is small in relation to the rest of the world, relies

heavily on imports, and has had, with the exception of brief periods of recession, an ample flow of foreign exchange consequent on its oil. The major cost items

impinging on consumer prices are import prices, local wage and salary costs, and

profit mark-ups. On the other hand, growth in money incomes and credit ex

pansion in excess of real output tend to pull up aggregate demand. Social groups will seek to protect their incomes against rising prices either by raising employee compensation through Trade Union activity or by raising mark-up over costs. More specifically, given the structure of the economy and the institutional con trols over wages, import prices will trigger off price increases, wage and salary increases will give compensatory upward adjustments to money incomes and

may impart some cost push, and against the background of a stable income

velocity and a well established demand function for money, such as demon strated by Chow [1], monetary and credit expansion will 'finance' the inflation and may further fuel it. Inflationary expectations will reinforce the process as

attempts are made to minimize the adverse effects of rising prices on disposable incomes, and in a pluralist democratic political framework [Lindsay 6] the

inflationary process may become continuous.

The Data. Because all data possessed strong trends,variables were defined as the percentage change from the previous year. Except where otherwise stated, data are for the years 1965 to 1976 inclusive, thus giving 11 observations.

Income Velocity. This was measured as the ratio of GDP at current prices to money supply. Two definitions of money supply are used, narrow money (Ml) defined as currency in active circulation plus demand deposits, and broad

money (M2) which, in addition, included time and savings deposits. The stability of income velocity may be judged from the following:



620 SOCIAL AND ECONOMIC STUDIES

TABLE II: Income Velocity

Arithmetic Mean ( ) Standard Deviation (s) Coefficient of Variation (s/x)%

The time path of V2 has been downward between 1968 and 1972 when

money supply rose faster than the relatively stagnant GDP. A significant trend

line was fitted to this data,

V2 = 3.43 - 0.096 t r2 = .43 s.e.= .51 tQ = 1971

(0.15) (0.48) d =0.15

VI showed some volatility but no significant trend, and except for the years

1973 to 1975 when, with the sharp increase in GDP following the oil boom,

velocity rose sharply, remained roughly constant. Fig. I illustrates. The con

clusion, however, that income velocity was fairly stable seems nonetheless

warranted for the short period 1966 to 1976.

The Demand for Money. If the income velocity is a parameter of the

system and the demand for money as an asset is a stable function of wealth/

income and the opportunity cost of holding cash, then variations in the supply

of money will be felt in the goods market thus creating excess demand in times

of monetary expansion. Table I shows that broad money (M2) has grown more

rapidly than narrow money (Ml), and both have grown more rapidly since 1972.

However Ml has grown at about the same rate as GDP at current prices for all

I_,_,-1-,?.?.?.?.? ?.->

1966 67 68 69 70 71 72 73 74 75 76 Year

Figure 1 : Income Velocity

VI = GDP/Ml 11.1

1.6 14.4

V2 = GDP/M2 3.4 0.5

14.7




the sub-periods since 1965, and while M2 has grown faster than GDP between 1965 and 1972, its rate of growth about matched that of GDP over the 1965/76 period as well as over the shorter period 1972/76. Prima facie there may be

evidence for credit-expansion-led inflation prior to 1972 but hardly since that date when in fact the rate of price increases accelerated.

Demand functions for money were estimated by regression methods, the

percentage change in money supply being the dependent variable: and the inde

pendent variables being current price GDP, and two measures of short term interest rates. Experiments confirmed a priori expectations that long term inter est rates, e.g. the bond rate, were not relevant. Of the short term rates used, the

percentage change in commercial banks' average rate on deposits (r2) was

superior to the percentage change in the Treasury Bill rate (rl). Only 9 data

points were available from the period 1967 to 1976 and the results must be

interpreted with due regard to this limitation.

TABLE III: Demand Functions for Money

Money Variable Constant Y rl r2 R2 d s.e. Ml: Central Bank Data 13.46 0.45 -0.26* .40 1.8 17.0

( 8.72) (0.3< \ (0.16) 12.81 0.54** -0.43** .55 2.4 14.8

( 7.60) (0.32) ( 0.20) Ml:CSOData 6.77 0.55** -0.27* .46 1.0 16.9

( 8.65) (0.36) ( 0.17) 5.96 0.65** -0.50** .69 1.6 12.8

( 6.57) (0.27) (0.17) M2:CSOData 15.64 0.29** -0.09 .50 0.8 6.8

( 3.47) (0.14) ( 0.07) ( 2.91) (0.12)** ( 0.07)** .66 1.6 5.7

Significant at 10% **Significant at 5%

Generally, overall fits are good, since the variables are percentage changes, serial correlation as judged by the d-statistics absent, and standard errors are small indicating that parameter estimates are reasonably well established. Parameter estimates all conform a priori to expected sign, and the magnitude of the coefficient estimates for Ml compared to M2 turn out as expected. The coefficient estimates are directly the elasticities. It seems reasonable to conclude that there is a stable demand function for money.

Import Prices as the Trigger.

Once the pattern of domestic prices and supplies are established and in comes are growing at an even rate, there would be no tendency for the economic

system to move away from this equilibrium. Supplies will be imported or put on

the market from domestic sources, an accustomed mark-up will be added, and

prices would tend to be stable. However if import prices were to increase, this




will give rise to a prompt upward change in the relevant prices, and a chain of

adjustments set in motion, spilling over to encompass the prices of domestic

goods and factors. A once and for all change may not set up a spiral, and the

system may return to equilibrium in a short space of time.5 However ifimport prices continue to rise there is set in train successive waves of price and wage adjustments, and the expectations of further increases can cause economic actors to try to forge ahead, and to hedge against further inflation by advancing pur chaseSo Thus if financing is available through easy credit and an expansionist monetary policy, inflationary pressures may be generated from both the supply side (raising costs) and the demand side (excess spending). An increasing flow of

foreign exchange would seem, in the specific case of Trinidad and Tobago, to

permit an increasing flow of imports, and an automatic expansion of the money supply as Thomas [11] has shown.

The attempt to isolate the relative contribution of import prices, monetary expansion, wage push/wage demand pull, and expectations as explanatory factors, led us to fit the following price equations. All variables are measured as

percentage changes, and the time period is the years 1964 to 1976. The

dependent variable is the percentage change in prices and price expectations approximately measured as the change in the percentage change in prices. The small number of observations make the Durbin-Watson test not strictly valid.

TABLE IV: Price Equations

Lagged Current Lagged Price

Import Wage Money Money Expecta Constant Prices Rates Supply Supply tion R d s.e d.f.

-2.94 0.40 0.09 0.25 - 0.39 .92 2.3 2.5 6

(1.96) (0.12) (0.18) (0.12) (0.18) -2.90 0.43 - 0.26 - 0.36 .92 2.2 2.4 7

( 1.84) (0.09) (0.11) (0.16) -3.80 0.41 - 0.18 0.17 0.46 .94 2.3 2.2 6

( 1.84) (0.09) (0.12) (0.11) (0.17)

Experimentation with alternative specifications of this general price equation indicated a number of crucially important matters. The stability of the fitted line and the absence of serial correlation required the inclusion of the

price expectations variable, which in every case turned out significant in spite of its low zero order correlation (0.34) with the price variable. The current wage level, though highly correlated with the price variable (0.86), added nothing to the explanation of prices, and even when lagged (zero order correlation r = 0.84) performed no better. The most meaningful measure of the monetary variable was

broad money (M2), and by itself was, with or without lags, a weak explanatory variable for prices. Import prices turned out in every case where included in the

regressions, whether alone or in combination with other variables, to be a stable




and significant variable. Thus import prices, price expectations, and money supply (both current and lagged) turned out to be the factors of significance in

explaining prices. Table IV presents the key results which, generally speaking, were very well established and show stable parameter or elasticity estimates. Prima facie there seemed no wage push or wage demand inflation, or put less

strongly, the wage variable added nothing to the explanation of prices over and above the contribution of import prices, money supply and price expectations.

Causation

One of the more interesting features of the analysis was the attempt to dis criminate empirically between competing explanations of the genesis and trans mission of the inflation in Trinidad and Tobago. In order to throw some light on the problem, the technique of the analysis of variance, based on the regres sions, was used in an attempt to establish a hierarchy of causation. Table V

presents the analysis.

TABLE V: Analysis of Variance

Mean Sum of Square

Source of Variation Squares Error F.ratio d

Wage rates (W) 147.65 34.89 4.23*** 1,3 Money Supply (M) 209.86 27.98 7.50** 1.2 Import Prices (I) 375.52 9.57 39.24* 1.5

Wadded to I 0.22 10.74 0.02 1.5 I added to W 228.09 10.74 21.24* 1.5

Wadded to M 21.85 28.74 0.76 1.2 M added to W 84.06 28.74 2.92 1.2 M added to I 16.60 8.69 1.91 1.3

I added to M 182.26 8.69 20.97* 1.3 added to I and M 0.40 9.88 0.04 1.3

M~2 added to I, M and Mj 1.10 11.34 0.10 1.4 Price expectations ( / )

added to I and M 29.17 5.77 5.06*** 2.2

( / ) added to I, M and 38.86 5.05 7.70** 2.3 added to I, M and ( / ) 10.09 5.05 2.0 2.3

Total (10 degrees of freedom) 461.5 46.15 - -

*, **, ***, indicate significance at 1%, 5%> and 10% respectively.

When prices are regressed on import prices, money supply and price expec tations, the appropriate F ratio is 24.33, and when lagged money supply is added the F-ratio is 21.37, both values being significant at 1 per cent. A clear

hierarchy is discernible. At the lowest level of explanatory powers stands wage rates, followed by money supply and import prices. Import prices add signi ficantly to the explanation whenever added. On the other hand wage rates add

nothing to that explained by money or import prices. The addition of monetary variables does not add significantly to the overall explanation, though in the




regressions the coefficients of the monetary variables are significant at 10 per cent or higher levels for both current and lagged values. The addition of price expectations adds significantly to the explanation and improves the Durbin

Watson statistic considerably. The inclusion of a price expectations variable seems crucial to the specification of the pricing equation.

Wage Transmission

The wages variable did not seem to be significant in pushing prices up wards. However, wages seemed to have served to transmit the inflation by spread ing higher money incomes through the economy and helping to keep money demand buoyant. Casual empiricism suggests that recent wage demands and

settlements in Trinidad and Tobago have reflected to a substantial extent the

increases in the cost of living over the life of the last agreement. Criteria such as

'ability to pay', 'a living wage', and 'wage comparisons', although they have

featured in the public debates, seemed to have been swamped by price increases of the magnitude that occurred during the sample period.

Where wage costs rise more rapidly than productivity, orthodox theory leads us to expect that, with a neutral monetary policy, prices would be pushed

upwards. In Trinidad and Tobago, because the vast bulk of total output is

exported,6 and wages are a relatively small fraction of incomes (and costs), and

because the bulk of supply originates overseas, no simple wage push hypothesis could be postulated. Where, however, wage and salary incomes are rising rapidly and there are supply bottlenecks (e.g. in local assembly plants), there may be a

tendency for wage demand pull inflation. The experience does not support this

weaker hypothesis, however. On a wage push/wage demand pull hypothesis the

period 1956/65 should show rapid inflation since wage rates grew at 8.3 per cent

per annum. Yet this was a period of price stability, retail prices rising at 2.4 per cent per year. Over the same period however, real output grew at about the same

rate as wage rates and money supply growth was considerably slower as Table I

indicates. Since 1965 wage increases have, on average, exceeded price increases

by only a slight margin. At the same time real GDP has risen substantially,

particularly since 1972, and the wage increases gained might have permitted those employed to share somewhat in the increased prosperity.

A number of hypotheses about wages were tested and discarded. The

extent to which there was wage leadership was examined by dividing industries

into those in which the growth rate of wages over the past twenty years ex

ceeded the average, and those in which growth rate was slower than average,7 the former group being regarded as leaders. Indices of wage rates for these two

groups were computed. An attempt was then made to explain the behaviour of

wage rates in the leaders by reference to past price changes and certain measures

of national prosperity such as the growth in oil output and the growth in

government revenues. Wage increases in the other industries, the followers, were




then related to wage increases in the leaders. These experiments seemed not to have provided much enlightenment and were abandoned.

In the end the hypothesis which seemed to explain the data was that which related the percentage change in wages to the percentage change in prices with lags up to three years, the normal length of wage agreements. Not unex

pectedly current price changes were not significant, lagged prices had coefficients of about equal size, and the significance of the variables weakened as the lag was

lengthened. Table VI presents the results.

TABLE VI: Influence of Prices on Wage Rates

Constant P-l P-2 P-3 R2 d s.c

1.81 0.52** 0.65** .84 1.5 3.7

(1.73) (0.25) (0.26) 1.04 0.48** 0.44* 0.50 .86 1.7 3.6 (1.80) (0.25) (0.31) (0.41)

*Significant at 10%, **

Significant at 5%

Further experiments with Almon lag functions for lags of three periods and polynomials of second and third degree indicated no significant time shape in the coefficients. As expected, the wage bargain attempts to recoup all lost

ground consequent on rising prices.

Summary

The Trinidad and Tobago inflation of recent years took place against the

background of rising real incomes consequent on windfall gains from petroleum, and a rapidly expanding money supply. Prior to 1973 the economy had ex

perienced rather sluggish growth. Rapid growth in money supply began in about

1966, and except for a brief period of tight money in 1973, there has been easy credit, expansionist monetary policy, and high liquidity in the system. The data

indicate that the proximate causes of the inflation, in a macro-economic sense, have been import prices which acted as a trigger, money supply which served a

permissive role at the very least, and expectations which reinforced the spiral. It seems that wages played a passive role and may have served merely to spread

money incomes and so to transmit the inflation.



626. SOCIAL AND ECONOMIC STUDIES

FOOTNOTES

The population of Trinidad and Tobago is just over 1 million and its GDP was

TT$5607m in 1976. In June 1976 the TT $ was realigned to the US$ at the rate US$1 =

TT$2.40 prior to which date it was pegged to the pound sterling at fl = TT$4.80. Imports other than oil u.p.a. as a share of GDP averaged 32 per cent between 1966 and 1976 while

domestic exports averaged 57 per cent.Oilcontributed 31 per cent to GDP between 1966

and 1976 and 46 per cent between 1974 and 1976 with the recent oil boom. Wages and all

employee compensation as a share of GDP averaged 38 per cent between 1957 and 1962.

2 For an analysis of the open petroleum economy see Seers [7].

3 This Act forbade strikes and established an Industrial Court for settling wage disputes.

Its introduction dampened the rate of wage increases significantly. See St. Cyr [9, p.96,

fn6].

4 For a more detailed analysis of the earlier data and information on their meaning, see

St. Cyr [9].

^This seems to have happened after the 1967 devaluation. Prices jumped 8.3 per cent

in 1968 but returned to normal from 1969.

^Between 1972 and 1976, domestic exports as a share of GDP averaged 76 per cent.

If however the petroleum sector is excluded, then domestic exports as a share of GDP

averaged only 16 per cent and the picture drastically modified.

See St. Cyr [9, Table III, p.96].




REFERENCES

[1] CHOW, Gregory C, "On the Long-Run and Short-Run Demand for

Money", Journal ofPolitical Economy, 1966.

[2] ECLA, Inflation and Growth - A Summary of Experience in Latin America -

E/CN. 12/563,1961. Also a 6 volume study by the same title.

[3] HARBERGER, A.C., "The Dynamics of Inflation in Chile", in C.

CHRIST, Measurement in Economics: Studies in Mathematical Economics and Econometrics in Memory of Yehuda Grunfield, Stanford University Press, 1963.

[4] KOOT, Ronald S., "A Test for Demand-Pull and Wage-Push Inflation", Social and Economic Studies, 1968.

[5] LAIDLER, David, and Michael PARKIN, "Inflation: A Survey", Economic Journal, 1975.

[6] LINDSAY, Louis, "The Politics of Inflation: An Unorthodox Per

spective", Social and Economic Studies, 1977.

[7] SEERS, Dudley, "The Mechanism of an Open Petroleum Economy", Social and Economic Studies, 1964.

[8] -, "A Theory of Inflation and Growth in Underdeveloped Economies based on the Experience of Latin America", Oxford Papers, 1962.

[9] St. CYR, E.B.A., "Rising Prices: An Exploratory Theoretical and

Empirical Study of Trinidad and Tobago", C.S.O. Research

Papers No. 7,1974.

[10] SUNKEL, O., "Inflation in Chile - An Orthodox Approach", Inter national Economic Papers, Vol. 10,1960.

[11] THOMAS, C.Y., "Monetary Arrangements in a Dependent Monetary Economy", Social andEconomic Studies, 1965, (Supplement).



a note on the trinidad and tobago inflationary experience, 1965-1976

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