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We are grateful to Paul Cashin and Catherine Pattillo for their insightful comments. Thanks are also due to Oya Celasun, Herman Kamil, Emilio Pineda, and Evridiki Tsounta, seminar participants at the Eastern Caribbean Central Bank, and the IMF’s Western Hemisphere Department.
The other currency union is formed by the CFA franc zone consolidating the two economic unions in Africa— West African Economic and Monetary Union (WAEMU) and the Economic and Monetary Community of Central Africa (CEMAC). While the ECCU fixed exchange rate is supported by a quasi-currency board arrangement—in that the Eastern Caribbean Central Bank needs to cover only 60 percent of its domestic liabilities with foreign reserves—in actuality it operates like a full fledged currency board with almost full coverage of demand liabilities.
The countries are: Antigua and Barbuda (ATG), Dominica (DMA), Grenada (GRD), St. Kitts and Nevis (KNA), St. Lucia (LCA), and St. Vincent and the Grenadines (VCT). Anguilla and Montserrat, two other ECCU members, are U.K. territories and not members of the Fund.
This paper uses “real exchange rate stability” and “purchasing power parity (PPP)” interchangeably, as movements in real exchange rate may be viewed as a measure of the deviation from PPP. See Sarno and Taylor (2002) for a literature survey on the real exchange rate and PPP.
For example, the post-2001 components of “food” and “alcoholic beverages and tobacco” are consolidated to one pre-2001 component of “food and beverages”. See Cashin and others (2004) for details.
Windward Island countries are Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines. Leeward Island countries are Antigua and Barbuda and St. Kitts and Nevis.
One caveat is that the production of nontradables would include tradable inputs, which we are unable to take into account in the absence of more disaggregated data of the ECCU CPI baskets.
The optimal lag length of cointegration is chosen according to the Schwartz Information Criterion.
Derived as a weighted average of prices in individual ECCU countries, using real GDP as the weight.
The implied half life is calculated as − ln 2/ln(1 + β).
The error correction term for St. Kitts and Nevis is found to be statistically insignificant in explaining short-run inflation dynamics.
Data on the components of CPI of the ECCU countries prior to 1990 were not available at quarterly frequency.
The above result holds regardless of the choice of benchmark ECCU country.
Dominica has allowed full pass through from the world oil prices to domestic prices since late 2003. Grenada and St. Kitts and Nevis liberalized the determination of retail gasoline prices in late 2006.