Business Cycles in the Eastern Caribbean Economies: The Role of Fiscal Policy and Interest Rates

32 Pages Posted: 20 Apr 2016

See all articles by Francisco Carneiro

Francisco Carneiro

The World Bank

Viktoria V. Hnatkovska

University of British Columbia (UBC) - Department of Economics

Date Written: January 27, 2016

Abstract

This paper analyzes the business cycle characteristics of the economies of the Organization of Eastern Caribbean States using a model of a small open economy subject to interest rate and fiscal expenditure shocks and financial frictions. The paper shows that macroeconomic aggregates in this region are quite volatile, with consumption exhibiting higher volatility than gross domestic product. The analysis also finds that in these economies real interest rates are highly volatile and strongly countercyclical with gross domestic product and other macroeconomic aggregates. Similarly, fiscal expenditures show significant volatility, but are pro-cyclical with gross domestic product. The results suggest two major directions for designing policies to help reduce the volatility experienced by the Organization of Eastern Caribbean States economies. First, Organization of Eastern Caribbean States countries should seek a greater openness to international financial markets, which could help them smooth out the effects of fundamental shocks, such as shocks to technology and terms of trade, and shocks associated with natural hazards. However, this removal of international financial barriers needs to be accompanied by improvements in domestic financial conditions, as this would reduce the vulnerability of these economies to country risk premium shocks. Second, the Organization of Eastern Caribbean States region should try harder to move toward a countercyclical fiscal policy stance, as this could help to stabilize the domestic risk premium and cushion the negative effects of interest rate shocks on economic activity, hence reducing volatility.

Keywords: Macro-Fiscal Policy, Public Sector Economics, Financial Economics, Public Finance Decentralization and Poverty Reduction, Trade and Multilateral Issues, Finance and Development, Economic Policy, Institutions and Governance, Economic Adjustment and Lending

Suggested Citation

Carneiro, Francisco Galrao and Hnatkovska, Viktoria V., Business Cycles in the Eastern Caribbean Economies: The Role of Fiscal Policy and Interest Rates (January 27, 2016). World Bank Policy Research Working Paper No. 7545. Available at SSRN: https://ssrn.com/abstract=2723690

Francisco Galrao Carneiro (Contact Author)

The World Bank ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

Viktoria V. Hnatkovska

University of British Columbia (UBC) - Department of Economics ( email )

997-1873 East Mall
Vancouver, BC V6T 1Z1
Canada

HOME PAGE: http://faculty.arts.ubc.ca/vhnatkovska/

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