ANNEX: Data Sources
Fiscal stance proxies.(i) Primary balance divided by nominal GDP: For the ECCU countries, data for primary balance and GDP during 1983–1990 was obtained from the Eastern Caribbean Central Bank (ECCB), while data after 1990 was obtained from IMF, Western Hemisphere Department. For the non-ECCU countries data was obtained from the IMF’s World Economic Outlook (WEO) (series GCBXI for primary balance, and series NGDP for nominal GDP). For Haiti, in the absence of data on primary balance, fiscal stance was proxied by overall balance (WEO, series GGB). (ii) Primary expenditure, divided by nominal GDP: For the ECCU countries, the primary expenditure series before 1990 was obtained from the ECCB, while that after 1990 was from the Western Hemisphere Department, desk data. For the non-ECCU countries, the data was obtained from WEO (series GCENL).
De facto exchange rate regime. Reinhart-Rogoff (2002) classification of exchange rate regimes and the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.
Gross domestic product. For ECCU countries from IMF, Western Hemisphere Department. For the rest of the Caribbean countries from WEO (series W_NGDP_R).
Election dates. From Database of Political Institutions, World Bank.
ECCB foreign reserves coverage was measured by the ratio of foreign assets at the ECCB in terms of reserve money (lines 1L. DZF and 14…ZF in IMF’s International Financial Statistics, IFS). Nominal exchange rate between EC$ and US$ (series AE.ZF in IFS) was used to convert foreign assets of the ECCB in US$ to that in EC$.
Terms of trade. WEO, Series W_TT.
Openness. Defined as the sum of exports and imports of goods and services, divided by nominal gross domestic product. For ECCU countries, these series were obtained from the IFS, series codes 90C..ZF… (exports), 98C..ZF… (imports) and 99B..ZF… (nominal GDP). For rest of Caribbean, the series were obtained from WEO: WEO W_NX (exports), W_NM (imports) and W_NGDP (nominal GDP).
Bayoumi, T., M. Goldstein, and G. Wolgrom, 1995, “Do Credit Markets Discipline Sovereign Borrowers? Evidence from U.S. States,” Journal of Money Credit and Banking, Vol. 27, pp. 1046–1056.
Chari, V.V. and P. Kehoe, 2004, “On the Need for Fiscal Constraints in a Monetary Union,” Federal Reserve Bank of Minneapolis, NBER Working paper No. 10232 (Cambridge, MA: National Bureau of Economic Research).
Chow, G. C., 1960, “Tests of Equality between Sets of Coefficients in Two Linear Regressions,” Econometrica, Vol. 28, pp. 591–605.
Duttagupta, R. and G. Tolosa, 2005, “Fiscal Policy in a Regional Currency Board: Is the` ECCU a Free-Riding Paradise?,” forthcoming IMF Working Paper (Washington DC: International Monetary Fund).
Fatas, A. and A. Rose, 2001, “Do Monetary Handcuffs Restrain Leviathan? Fiscal Policies in Extreme Exchange Rate Regimes,” IMF Staff Papers, Vol. 47, Special Issue, pp. 40–61.
Frenkel, J., M. Goldstein, and P. Masson, 1991, “Characteristics of a Successful Exchange Rate System,” IMF Occasional Paper No. 82 (Washington DC: International Monetary Fund).
Giavazzi, F. and M. Pagano, 1988, “The Advantage of Tying One’s Hands: EMS Discipline and Central Bank Credibility,” European Economic Review, Vol. 32, pp. 1055–1075.
Hendrickson, M., K. Katjomuise, H. McBain, and E. Pérez, 2002, “Monetary, Fiscal Policy and Economic Performance in a Monetary Union—The Case of the Eastern Caribbean Currency Union,” mimeo, ECLAC.
International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions (Washington DC: International Monetary Fund).
Kaminsky, G., C. Reinhart, and C. Végh, 2004, “When it Rains, it Pours: Procyclical Capital Flows and Macroeconomic Policies,” NBER Working Paper No. 10780 (Cambridge, MA: National Bureau of Economic Research).
Krugman, P. 1979, “A Model of Balance of Payments Crisis,” Journal of Money, Credit and Banking, Vol. 11, pp. 311–325.
Manasse, P., N. Roubini, and A. Schimmelpfennig, 2003, “Predicting Sovereign Debt Crisis”, IMF Working Paper WP/03/221 (Washington DC: International Monetary Fund).
Rasmussen, T., 2004, “Macroeconomic Implications of Natural Disasters in the Caribbean,” IMF Working Paper WP/04/224 (Washington DC: International Monetary Fund).
Rasmussen, T. and G. Tolosa, 2005, “Islands of Stability? Determinants of Macroeconomic Volatility in the ECCU,” in Eastern Caribbean Currency Union—Selected Issues, Chapter II.
Reinhart, C., 2002, “Default, Currency Crises and Sovereign Credit Ratings,” NBER Working Paper No. 8738. Also published in The World Bank Economic Review, Vol. 16, pp. 151–170.
Reinhart, C. and K. Rogoff, 2002, “The Modern History of Exchange Rate Arrangements: A Reinterpretation,” NBER Working Paper 8963 (Cambridge, MA: National Bureau of Economic Research).
Reinhart, C., K. Rogoff, and M. Savastano, 2003, “Debt Intolerance,” NBER Working Paper No. 9908 (Cambridge, MA: National Bureau of Economic Research).
Sahay, R., 2005, “Stabilization, Debt and Fiscal Policy in the Caribbean” IMF Working Paper WP/05/26 (Washington DC: International Monetary Fund).
Sargent, T. and N. Wallace, 1981, “Some Unpleasant Monetarist Arithmetic,” Federal Reserve Bank of Minnesota Quarterly Review, Vol. 5(3).
Sun, Y., 2003, “Do Fixed Exchange Rates Induce More Fiscal Discipline?,” IMF Working Paper WP/03/78 (Washington DC: International Monetary Fund).
Tornell, A. and A. Velasco, 2000, “Fixed or Flexible Exchange Rates: Which Provides More Fiscal Discipline?,” Journal of Monetary Economics, Vol. 45, pp. 399–436.
van Beek, F., J.R. Rosales, M. Zermeno, R. Randall, and J. Shepherd, 2000, The Eastern Caribbean Currency Union, IMF Occasional Paper 195 (Washington DC: International Monetary Fund).
von Hagen, J. and I. Harden, 1996, “Budget Processes and Commitment to Fiscal Discipline,” IMF Working Paper WP/96/78 (Washington DC: International Monetary Fund).
Prepared by Rupa Duttagupta and Guillermo Tolosa.
Besides the ECCU, the only other currently operating currency union with a fixed exchange rate regime is the CFA franc zone, which comprises the West African Economic and Monetary Union (WAEMU) and the Central African Economic and Monetary Union (CEMAC). The Euro Area, while also representing a currency union, is different from the ECCU and the CFA zone in that the common currency in the union freely floats against all other major international currencies.
The sample comprises the ECCU6—Antigua and Barbuda, Dominica, Grenada, St. Lucia, St. Kitts and Nevis, and St. Vincent and Grenadines—and 9 other Caribbean countries including, The Bahamas, Barbados, Belize, Dominican Republic, Guyana, Haiti, Jamaica, Suriname, and Trinidad and Tobago.
Abstracting from relative prices, inflation and devaluation are equivalent. In addition, a jump in the price level is also considered inflation for the purposes at hand.
The beneficial effects of inflation on public accounts are twofold: Tornell and Velasco (2000) stress the seignorage deriving from the devaluation, while Chari and Kehoe (2004) stress the deflation of debt in domestic currency.
Note that the only type of free riding behavior under consideration is with respect to the burden of the inflation tax. Other forms of free riding, e.g., higher future taxes or lower future social expenditure controls, are not considered here.
Intertemporal free-riding is also linked with the cost of realignment of the peg—the higher the cost, the lower the probability of free-riding intertemporally (see Sun, 2003).
Henceforth, the quasi-currency board arrangement will be referred to as the CBA for the sake of simplicity.
However, the existence of fiscal rules per se may not be enough to induce fiscal discipline (as confirmed by the recent experience in the Euro Area).
In the sample of 15 countries, the ECCU countries maintained a regional currency board, while The Bahamas, Barbados and Belize maintained conventional fixed peg regimes through out the sample period. Other countries maintained a variety of exchange rate regimes during the sample period, including floats and intermediate exchange rate regimes.
Sahay (2005) analyzes the public debt dynamics of a sample of 15 Caribbean countries and finds that the ECCU countries are among the highest for emerging market economies. In addition, most of the increase in public debt is accounted for by a deterioration in primary balances.
See Kaminsky et al. (2004) and Rasmussen and Tolosa (2005). The higher influx of net capital inflows since the mid-1990s was unrelated to changes in capital account policies, as the region had eliminated most capital controls in the early 1980s (see IMF Annual Report on Exchange Arrangements and Exchange Restrictions, various issues).
Reinhart et al. (2003) find evidence that borrowing capacity is significantly related to default histories and the nature of macroeconomic volatilities.
Data for institutional variables that are usually cited in the literature—for example, fiscal transparency, characteristics of the budget process, independence of the Ministry of Finance over the Cabinet, the degree of expenditure control by the budget authority (von Hagen and Harden, 1996)—are very poor for the Caribbean.
The data sources of all the indicators are documented in the Annex.
Note however, the correlation between primary balance and proximity to elections for fixed peg regimes, while expected to be negative, is negligible.
The group of fixed peg regimes comprises countries which maintained fixed pegs during the entire sample period, with negligible adjustment in the exchange rate level (i.e., less than 1 percent). While it would also be interesting to single out the effect of pure floating regimes on fiscal policy, no country maintained a float during the entire sample period.
See Wildasin (1997) for a similar argument. For instance, the countries that violated the Stability and Growth Pact in Europe were its largest members, France and Germany.
To avoid endogeneity between some of the right-hand side explanatory variables (real GDP growth, trade openness, foreign reserves) with the primary balance, one-year lagged values of the explanatory variables are used.
While the same result also holds for countries with fixed peg regimes, the effect is not statistically significant.
The data for natural disasters were taken from Rasmussen (2004). To save degrees of freedom, each dummy was added individually to the regression (in Column II), and accepted only if its coefficient was significant at the 10 percent level.
This result also supports the perception that the sectors responsible for high growth in the region (e.g., tourism) are under taxed, resulting in sluggish fiscal revenue growth even in times of robust economic recovery.