Factors in the Choice of an Exchange Rate Regime: With Special Reference to the Caribbean

• Author: Courtney Blackman
• Pages: 177-204

AN EXCHANGE RATE REGIME

177

The exchange rate is the most important price in any country; it

determines the terms of trade with foreigners as well as relative

prices within the economy. ‘Establishment’ economists are quick

to point out the negative implications of an over-valued exchange

rate; they are silent about the deleterious effects of an under-

valued exchange rate. However, the profession is unanimous about

the benefits of exchange rate stability, that is, an exchange rate to

whose fluctuations or trends the domestic economy can adjust

with relative ease.

In the 1950s and 1960s ‘free market’ economists, led by Milton

Friedman, argued that free-floating exchange rates would

promote exchange rate stability worldwide and so welcomed the

collapse of the Bretton-Woods fixed exchange rate system in 1971.

Instead of the promised stability, there has been such widespread

and sharp exchange rate volatility that West European

industrialized nations sought refuge in a common currency.

Emerging economies in Latin America and Asia have been most

severely affected by exchange rate instability. Succumbing to

pressure from the ‘Washington Consensus’, they deregulated their

financial markets, floated their currencies and opened their

financial markets to unfettered global capital flows. When

international financial crises struck and foreign capital inflows were

reversed, their financial markets collapsed, leading to deep

9

FACTORS IN THE CHOICE OF AN

EXCHANGE RATE REGIME

WITH SPECIAL REFERENCE TO THE CARIBBEAN

THE PRACTICE OF ECONOMIC MANAGEMENT

178

currency devaluations, high inflation and unsustainable

accumulations of foreign debt. Only those escaped who retained

an element of capital control, or were prepared to intervene

intelligently and pragmatically in their capital markets.

CARICOM member states have at various times employed the

fixed exchange rate, the currency board, the peg to a basket of

currencies, the foreign currency auction, the interbank market,

the cambio system, the free float and the managed float. This

paper reviews the CARICOM experience with various exchange

rate regimes over the past three decades, with special attention

to foreign exchange markets in conditions of chronic

disequilibrium. A number of lessons are extracted which should

be especially helpful to other small LDCs in the choice of an

appropriate exchange rate regime.

In conclusion, the paper summarizes the factors relevant to

the choice of an appropriate exchange rate regime. The chief

consideration is the quality of financial markets, that is, their

breadth, depth and competitiveness.

Lessons from the Anglophone CARICOM Experience

The Anglophone member states of CARICOM provide an

excellent laboratory for the study of exchange rates.1 Four of them

operate fixed exchange rate regimes — The Bahamas, Barbados,

Belize, and the Organization of Eastern Caribbean States (OECS),

comprising Antigua and Barbuda, Dominica, Grenada, St. Kitts

and Nevis, Saint Lucia, St.Vincent and the Grenadines, and the

two remaining British colonies of Anguilla and Montserrat. Guyana

and Jamaica have operated floating exchange rate regimes, with

the latter intervening periodically after 1994 in the foreign

exchange market; Trinidad and Tobago (T&T) has conducted a

managed float operation since 1993.

All CARICOM Central Bank Acts include currency stability

among their objectives, and all have at their disposal the traditional