ABSTRACT

This chapter focuses on small open financially integrated economies (SOFIEs), which are characterized by high export concentration; a limited range of competitive tradeable production, compared with import needs; and a domestic financial system which is fully integrated into world financial markets. It explains why the structural characteristics render exchange rate adjustment ineffective as a tool for increasing international competitiveness. The chapter provides evidence that confirms the widespread conviction that SOFIEs that have successfully anchored their exchange rates have achieved greater economic prosperity. It describes a framework for anchoring the exchange rate through the use of fiscal policy to manage aggregate demand. The chapter concludes with a description of the policy framework used in Barbados, which is designed to equip economic policy makers with the tools to achieve the external balance that is crucial to the stability of the exchange rate and the maintenance of investor confidence.