Monetary and Fiscal Coordination in Small Open Economies

Economic Institutions for a Resilient Caribbean

“…have independent monetary policy in the international environment of free capital mobility, since cross-border flows and leverage of global institutions transmit monetary conditions globally even under floating exchange rate regimes. In addition, according to Worrell (2000), small and open economies with flexible exchange rates are susceptible to contagion and exchange rate instability because their financial markets are, in general, not highly developed, while their exchange markets are very small (see also Pereira [2018]). Relatively few transactions can cause high exchange rate volatility, negatively affecting the central bank's credibility.…”

Seychelles: Recent Economic Developments

“…Because financial markets and financial intermediation in small-country economies do not function as efficiently as in large industrial countries, the monetary transmission mechanism in the former countries is surrounded by uncertainty. Worrell (2000) mentions two particular problems. First, discontinuities in the reaction to interest rate changes, owing to the importance of information and transaction costs, prevent rapid and full portfolio adjustment.…”

“…Worse, the very high real interest rates that might be required can be detrimental to investment, thus preventing the economy from reaching a sustainable expansion path. In the context of this specific monetary policy framework, Worrell (2000) argues that, in very small economies, central bank autonomy should not go as far as in big industrial economies. Because the market mechanism is missing in the monetary transmission process, a separation of responsibilities by itself will not guarantee the desired outcome.…”