Stable exchange rates ‘the better option’
A NEW STUDY has sought to debunk the “popular notion” that exchange rate flexibility is a good thing for countries like Barbados.
This “orthodox” view was simply an “illusion” and “misperception”, concluded Central Bank Governor Dr DeLisle Worrell, Professor Winston Moore, head of the department of economics at the University of the West Indies, Cave Hill Campus, and Central Bank economist Jamila Beckles.
In their new research Prosperity And The Exchange Rate Regime In Small Open Economies, the trio said their study provided “empirical evidence in support of the popular notion that stable exchange rates in small open economies are unambiguously a good thing, because stable exchange rates produce better growth outcomes, as well as promote financial stability and reducing financial risks”.
“This evidence corrects the orthodox economic thesis that there is a competitive benefit to exchange rate flexibility, irrespective of the size and openness of the economy, and that targeting the exchange rate therefore involves a sacrifice of potential growth,” they said.
“The apparent support for the orthodox view which is found in the literature is an illusion, created by a misperception of the measure of exchange rate volatility that matters for small European countries.
“Market agents in those countries measure their currency’s volatility in terms of the euro, not the US dollar. Once this correction is made, we uncover the underlying negative relationship between exchange rate volatility and economic development.”
The researchers said their paper “explores the difference in perception between economists and ordinary folk about the importance of stable exchange rates for small open economies”.
“Small open economies everywhere are preoccupied with exchange rate stability, whereas most economists believe that exchange rates should be managed flexibly to maintain competitiveness or allowed to float freely. To most non-economists it is fairly obvious that countries with more stable exchange rates are more prosperous. Our paper finds empirical evidence in support of that view,” they added.
The study said when determining that stable exchange rates were the best for countries like Barbados, it was important to do so by adopting “the most appropriate measure of prosperity and the correct definition of exchange rate stability”.
This included moving beyond the traditional gross domestic product measurement to include other factors including the United Nations’ Human Development Index. (SC)