How does this affect the small island economies of the Caribbean?

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Understanding Macroeconomic Volatility: Part 4. Click to read the rest of the series

Our work has confirmed that small island economies are particularly vulnerable to volatility, pro-cyclical spending and poor development of their domestic financial systems. Research that one of us conducted with Markus Bruekner in 2015 shows that pro-cyclical spending has a particularly strong effect of raising trade deficits in the eastern Caribbean states, as well as in other similar nations of the world. There’s even greater impact when you factor in the islands’ generally low financial development.
Carneiro and Hnatkovska (2016) broke down the business cycle characteristics of the eastern Caribbean countries and found that various macroeconomic aggregates there are quite volatile, with consumption more volatile than GDP. In these economies, real interest rates are very volatile and strongly countercyclical with GDP, the authors report—as GDP falls, interest rates rise. Similarly, fiscal expenditures showed significant volatility, but were pro-cyclical with GDP.
Carneiro and Hnatkoyska also showed that developing the domestic financial market helps buffer the effects of interest rate shocks on the economy. Simulations they conducted demonstrated that if island companies could find working capital in hard times—a more modern banking system could provide this—there would be a significant reduction in the volatility of GDP, consumption, employment, and government spending.


Francisco G. Carneiro

Economic Advisor, Front Office of the VP for Development Finance

Rei Odawara

Senior Country Economist

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