Presentation on theme: "Macroeconomic Stability and Economic Resilience: The Role of Macroeconomic Policies Lawrence Schembri Bank of Canada Prepared for International Conference."— Presentation transcript:
Macroeconomic Stability and Economic Resilience: The Role of Macroeconomic Policies Lawrence Schembri Bank of Canada Prepared for International Conference on Small States and Economic Resilience Malta, 23–25 April 2007 This presentation represents the views of the author, not the Bank of Canada.
Motivation: Why are we here? Ultimate economic goal of a nation state is economic growth that is high and stable (and therefore sustainable) → economic growth contributes to a higher quality of life Small states have difficulty achieving this goal –they are “economically vulnerable” (Briguglio); –they are “open” to adverse external shocks Our objective is to reduce the probability of an adverse impact by “nurturing” “economic resilience” (Briguglio, Cordina et al.)
Motivation: Why I am here? Definition “Economic resilience”: –An economy’s ability to recover from, withstand or avoid adverse economic shocks Index of Economic Resilience (4 Components) 1.Macroeconomic stability – MY TASK 2.Microeconomic market efficiency 3.Good governance 4.Social development My purpose: 1.Discuss how macroeconomic stability contributes to resilience and 2.Examine how it can be achieved through macroeconomic policy
Measuring Macroeconomic Stability In the Resilience Index, macroeconomic stability is broadly measured by: 1.Unemployment rate + Inflation rate 2.Fiscal deficit (as a ratio of GDP) 3.External debt (as a ratio of GDP) Only #1 is a measure of macro stability #2 and #3 are more accurately described as measures of effective stewardship of public and external resources
Key Hypotheses 1. Macroeconomic stability and effective stewardship of public and external resources “nurtures” or contributes to economic resilience 2. Macroeconomic stability and effective stewardship of public and external resources can be enhanced by appropriate domestic macroeconomic (& financial) policies
Outline 1.Provide a conceptual framework for these broad measures of macroeconomic stability and their contribution to resilience 2.Discuss how macroeconomic policies (that is, fiscal, monetary and exchange rate policies) contribute to macro stability 3.Analyse the macroeconomic experience of a sample of small states in order to draw useful policy lessons
Macroeconomic Stability: “Conceptual Framework” Ultimate economic goals: “nurturing” economic resilience and achieving high & stable growth Intermediate goals of public policy: 1.Internal balance 2.External balance 3.Effective stewardship of public resources 4.Effective stewardship of external resources 5.(Effective stewardship of private resources) Each of these intermediate goals fosters economic resilience and high & stable growth
Macroeconomic Stability: Meaning & Contribution to Resilience 1.Internal balance –Output at the full employment level –Low, stable & predictable inflation 2.External balance –A current account position that is roughly equal to a sustainable level of capital flows –Relative domestic prices that adjust smoothly to any imbalance Contribution to Resilience: An economy in internal & external balance can more easily withstand and recover from external shocks. Policies are in place to ensure flexibility & anchor expectations.
Effective Stewardship: Public Resources Meaning & Contribution to Resilience 1.Sustainable fiscal deficits & public debt → Debt service costs should be manageable Tax rates: low, broadly based and stable → Preserve incentives to work, save & invest 2.Expenditures on public goods maximize social returns Contribution to Resilience: Lessen vulnerability to crises with unsustainable debt loads; preserve flexibility to respond to shocks; and maintain internal balance.
Effective Stewardship: External Resources Meaning and Contribution to Resilience 1.External debt at sustainable levels → External debt service costs not too onerous 2.Balanced capital inflows → FDI and equity are less prone to reversals → FDI facilitates technology/knowledge transfer 3.Easy access to global markets → Allows borrowing & lending to smooth shocks and portfolio diversification to reduce risk Contribution to Resilience Reduce probability of crises due to high debt loads and unstable foreign borrowing and better diversify risks
Effective stewardship: Private resources Represented by the “microeconomic market efficiency” measures in the Resilience Index Examples: financial and labour markets Domestic financial markets should provide efficient intermediation of savings and access to risk diversification Labour markets should be flexible; wages should adjust or labour move easily in response to shocks
Fiscal Policy Contribution to Macroeconomic Stability Fiscal policy is critical to maintaining macro stability and “nurturing” economic resilience From a stabilization (internal balance) perspective: → Fiscal policy should be countercyclical → Fiscal policy should be automatic rather than discretionary To ensure that the public debt/GDP ratio is sustainable (& therefore preserve fiscal space to respond to external shocks), governments should commit to a long-run target for this ratio
Exchange Rate & Monetary Policy Contribution to Macroeconomic Stability Two policies must be discussed together Choice of exchange rate regime has direct implications for the monetary policy regime 1.Common currency → no domestic monetary policy 2.Fixed or heavily managed exchange rate → monetary policy must maintain the exchange rate 3.Flexible exchange rate → monetary policy independence, but central bank must chose a nominal anchor: inflation or money supply targeting Key Consideration: Stable nominal target to anchor expectations and maintain macro stability
Macroeconomic Policy Challenges in Small States Fiscal Policy Large demand for expenditures & transfers (governments play a large role; provide insurance) Tax collection inefficient (lack economies of scale; heavy reliance on import taxes) Chronic deficits often result that are not easy to finance (require financial institutions to hold debt) Monetary financing of deficits undermines exchange rate & monetary policy
Macroeconomic Policy Challenges in Small States Exchange Rate & Monetary Policy Difficult to conduct an independent monetary policy (thin domestic financial markets; low demand for monetary base; fiscal problems) Typical policy regimes: Common currencies; currency boards; fixed or heavily managed exchange rate regimes Import domestic monetary policy from abroad Lose the nominal exchange rate as a flexible adjustment mechanism; must rely on flexible wages and prices to absorb shocks
CountryPopulatio n (2006) GDP Billions of USD GDP per capita PPP Exchange rate regime Monetary Policy Framework Bahamas303,770$6.48$21,300Fixed peg to USDExchange rate anchor Barbados279,912$5.11$18,200Fixed peg to USDExchange rate anchor Fiji905,949$5.50$6,100 Fixed peg against a basket Exchange rate anchor Jamaica2,758,124$12.71$4,600FloatBase money target Malta400,214$8.12$20,300 Fixed peg to Euro Exchange rate anchor Mauritius1,240,827$16.72$13,500FloatInflation targeting Singapore492,150$138.6$30,900 Managed float against a USD, Euro and JPY. Exchange rate anchor
Coefficient of variation for Output Growth Country 1973 – – Bahamas Barbados Fiji Jamaica Malta Mauritius Singapore
Coefficient of variation for CPI Country 1973 – – Bahamas Barbados Fiji Jamaica Malta Mauritius Singapore
Summary of Findings Prudent fiscal policy seems to be prerequisite for achieving economic resilience and stable growth Low and stable inflation can be achieved with either a fixed or a managed floating exchange rate External debt and current account positions become less of a concern if domestic macroeconomic policies are appropriate
Concluding Remarks Economic resilience is an important and useful concept for small states Macroeconomic stability is critical to economic resilience Good fiscal, monetary and exchange rate policies can foster macroeconomic stability and “nurture” economic resilience Financial policies are also important for resilience; strong financial institution and access to global capitals Despite the challenges small states face, it is in their best interest to adopt best-practice macroeconomic policies
Closing Remark - Role of IMF Given the challenges small states face, the IMF (and other international organizations) should provide technical assistance to them to put in policies that will increase resilience They should also consider providing access to precautionary lines of credit so that these states can borrow when they are affected by an adverse economic shock