Presentation on theme: "Macroeconomic Stability and Economic Resilience:"— Presentation transcript:
1 Macroeconomic Stability and Economic Resilience: The Role of Macroeconomic PoliciesLawrence Schembri Bank of CanadaPrepared for International Conference on Small States and Economic Resilience Malta, 23–25 April 2007This presentation represents the views of the author, not the Bank of Canada.
2 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 lifeSmall states have difficulty achieving this goalthey are “economically vulnerable” (Briguglio);they are “open” to adverse external shocksOur objective is to reduce the probability of an adverse impact by “nurturing” “economic resilience” (Briguglio, Cordina et al.)
3 Motivation: Why I am here? Definition “Economic resilience”:An economy’s ability to recover from, withstand or avoid adverse economic shocksIndex of Economic Resilience (4 Components)Macroeconomic stability – MY TASKMicroeconomic market efficiencyGood governanceSocial developmentMy purpose:Discuss how macroeconomic stability contributes to resilience andExamine how it can be achieved through macroeconomic policy
4 Measuring Macroeconomic Stability In the Resilience Index, macroeconomic stability is broadly measured by:Unemployment rate + Inflation rateFiscal deficit (as a ratio of GDP)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
5 Key HypothesesMacroeconomic stability and effective stewardship of public and external resources “nurtures” or contributes to economic resilienceMacroeconomic stability and effective stewardship of public and external resources can be enhanced by appropriate domestic macroeconomic (& financial) policies
6 OutlineProvide a conceptual framework for these broad measures of macroeconomic stability and their contribution to resilienceDiscuss how macroeconomic policies (that is, fiscal, monetary and exchange rate policies) contribute to macro stabilityAnalyse the macroeconomic experience of a sample of small states in order to draw useful policy lessons
8 Macroeconomic Stability: “Conceptual Framework” Ultimate economic goals: “nurturing” economic resilience and achieving high & stable growthIntermediate goals of public policy:Internal balanceExternal balanceEffective stewardship of public resourcesEffective stewardship of external resources(Effective stewardship of private resources)Each of these intermediate goals fosters economic resilience and high & stable growth
9 Macroeconomic Stability: Meaning & Contribution to Resilience Internal balanceOutput at the full employment levelLow, stable & predictable inflationExternal balanceA current account position that is roughly equal to a sustainable level of capital flowsRelative domestic prices that adjust smoothly to any imbalanceContribution 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.
10 Effective Stewardship: Public Resources Meaning & Contribution to Resilience Sustainable fiscal deficits & public debt→ Debt service costs should be manageableTax rates: low, broadly based and stable→ Preserve incentives to work, save & investExpenditures on public goods maximize social returnsContribution to Resilience:Lessen vulnerability to crises with unsustainable debt loads; preserve flexibility to respond to shocks; and maintain internal balance.
11 Effective Stewardship: External Resources Meaning and Contribution to Resilience External debt at sustainable levels→ External debt service costs not too onerousBalanced capital inflows→ FDI and equity are less prone to reversals→ FDI facilitates technology/knowledge transferEasy access to global markets→ Allows borrowing & lending to smooth shocks and portfolio diversification to reduce riskContribution to ResilienceReduce probability of crises due to high debt loads and unstable foreign borrowing and better diversify risks
12 Effective stewardship: Private resources Represented by the “microeconomic market efficiency” measures in the Resilience IndexExamples: financial and labour marketsDomestic financial markets should provide efficient intermediation of savings and access to risk diversificationLabour markets should be flexible; wages should adjust or labour move easily in response to shocks
13 Fiscal Policy Contribution to Macroeconomic Stability Fiscal policy is critical to maintaining macro stability and “nurturing” economic resilienceFrom a stabilization (internal balance) perspective:→ Fiscal policy should be countercyclical→ Fiscal policy should be automatic rather than discretionaryTo 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
14 Exchange Rate & Monetary Policy Contribution to Macroeconomic Stability Two policies must be discussed togetherChoice of exchange rate regime has direct implications for the monetary policy regimeCommon currency → no domestic monetary policyFixed or heavily managed exchange rate → monetary policy must maintain the exchange rateFlexible exchange rate → monetary policy independence, but central bank must chose a nominal anchor: inflation or money supply targetingKey Consideration: Stable nominal target to anchor expectations and maintain macro stability
15 Macroeconomic Policy Challenges in Small States Fiscal PolicyLarge 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
16 Macroeconomic Policy Challenges in Small States Exchange Rate & Monetary PolicyDifficult 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 regimesImport domestic monetary policy from abroadLose the nominal exchange rate as a flexible adjustment mechanism; must rely on flexible wages and prices to absorb shocks
17 Monetary Policy Framework CountryPopulation (2006)GDP Billions of USDGDP per capitaPPPExchange rate regimeMonetary Policy FrameworkBahamas303,770$6.48$21,300Fixed peg to USDExchange rate anchorBarbados279,912$5.11$18,200Fiji905,949$5.50$6,100Fixed peg against a basketJamaica2,758,124$12.71$4,600FloatBase moneytargetMalta400,214$8.12$20,300Fixed peg to EuroMauritius1,240,827$16.72$13,500Inflation targetingSingapore492,150$138.6$30,900Managed float against a USD, Euro and JPY.
28 Coefficient of variation for Output Growth Country1973 – 20041973 – 1989Bahamas2.802.651.88Barbados2.081.732.78Fiji1.562.211.05Jamaica5.79-23.541.13Malta0.830.730.71Mauritius1.301.140.19Singapore0.530.440.64
29 Coefficient of variation for CPI Country1973 – 20051973 – 1989Bahamas0.720.470.76Barbados1.140.850.95Fiji0.640.440.59Jamaica0.500.91Malta0.971.020.32Mauritius0.810.790.37Singapore1.581.380.82
30 Summary of FindingsPrudent fiscal policy seems to be prerequisite for achieving economic resilience and stable growthLow and stable inflation can be achieved with either a fixed or a managed floating exchange rateExternal debt and current account positions become less of a concern if domestic macroeconomic policies are appropriate
31 Concluding RemarksEconomic resilience is an important and useful concept for small statesMacroeconomic stability is critical to economic resilienceGood fiscal, monetary and exchange rate policies can foster macroeconomic stability and “nurture” economic resilienceFinancial policies are also important for resilience; strong financial institution and access to global capitalsDespite the challenges small states face, it is in their best interest to adopt best-practice macroeconomic policies
32 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 resilienceThey 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