1. Macroeconomic Stability and Economic Resilience:
The Role of Macroeconomic Policies
Lawrence Schembri Bank of Canada
Prepared for International Conference on Small States and Economic Resilience Malta, 23–25 April 2007
This presentation represents the views of the author, not the Bank of Canada.

2. Motivation: Why are we here?
Ultimate economic goal of a nation state is economic growth that is high and stable (and therefore sustainable)
→ economic growth contributes to a higher quality of life
Small states have difficulty achieving this goal
they are “economically vulnerable” (Briguglio);
they are “open” to adverse external shocks
Our objective is to reduce the probability of an adverse impact by “nurturing” “economic resilience” (Briguglio, Cordina et al.)

3. Motivation: Why I am here?
Definition “Economic resilience”:
An economy’s ability to recover from, withstand or avoid adverse economic shocks
Index of Economic Resilience (4 Components)
Macroeconomic stability – MY TASK
Microeconomic market efficiency
Good governance
Social development
My purpose:
Discuss how macroeconomic stability contributes to resilience and
Examine how it can be achieved through macroeconomic policy

4. Measuring Macroeconomic Stability
In the Resilience Index, macroeconomic stability is broadly measured by:
Unemployment rate + Inflation rate
Fiscal deficit (as a ratio of GDP)
External debt (as a ratio of GDP)
Only #1 is a measure of macro stability
#2 and #3 are more accurately described as measures of effective stewardship of public and external resources

5. Key Hypotheses
Macroeconomic stability and effective stewardship of public and external resources “nurtures” or contributes to economic resilience
Macroeconomic stability and effective stewardship of public and external resources can be enhanced by appropriate domestic macroeconomic (& financial) policies

6. Outline
Provide a conceptual framework for these broad measures of macroeconomic stability and their contribution to resilience
Discuss how macroeconomic policies (that is, fiscal, monetary and exchange rate policies) contribute to macro stability
Analyse the macroeconomic experience of a sample of small states in order to draw useful policy lessons

7. Conceptual Framework “High Level”
Macroeconomic & Financial Policies
Macro Stability & Effective Stewardship of Public, External & Private Resources
Economic Resilience
Economic Growth

8. Macroeconomic Stability: “Conceptual Framework”
Ultimate economic goals: “nurturing” economic resilience and achieving high & stable growth
Intermediate goals of public policy:
Internal balance
External balance
Effective stewardship of public resources
Effective stewardship of external resources
(Effective stewardship of private resources)
Each of these intermediate goals fosters economic resilience and high & stable growth

9. Macroeconomic Stability: Meaning & Contribution to Resilience
Internal balance
Output at the full employment level
Low, stable & predictable inflation
External balance
A current account position that is roughly equal to a sustainable level of capital flows
Relative domestic prices that adjust smoothly to any imbalance
Contribution to Resilience:
An economy in internal & external balance can more easily withstand and recover from external shocks. Policies are in place to ensure flexibility & anchor expectations.

10. Effective Stewardship: Public Resources Meaning & Contribution to Resilience
Sustainable fiscal deficits & public debt
→ Debt service costs should be manageable
Tax rates: low, broadly based and stable
→ Preserve incentives to work, save & invest
Expenditures on public goods maximize social returns
Contribution to Resilience:
Lessen vulnerability to crises with unsustainable debt loads; preserve flexibility to respond to shocks; and maintain internal balance.

11. Effective Stewardship: External Resources Meaning and Contribution to Resilience
External debt at sustainable levels
→ External debt service costs not too onerous
Balanced capital inflows
→ FDI and equity are less prone to reversals
→ FDI facilitates technology/knowledge transfer
Easy access to global markets
→ Allows borrowing & lending to smooth shocks and portfolio diversification to reduce risk
Contribution to Resilience
Reduce probability of crises due to high debt loads and unstable foreign borrowing and better diversify risks

12. Effective stewardship: Private resources
Represented by the “microeconomic market efficiency” measures in the Resilience Index
Examples: financial and labour markets
Domestic financial markets should provide efficient intermediation of savings and access to risk diversification
Labour markets should be flexible; wages should adjust or labour move easily in response to shocks

13. Fiscal Policy Contribution to Macroeconomic Stability
Fiscal policy is critical to maintaining macro stability and “nurturing” economic resilience
From a stabilization (internal balance) perspective:
→ Fiscal policy should be countercyclical
→ Fiscal policy should be automatic rather than discretionary
To ensure that the public debt/GDP ratio is sustainable (& therefore preserve fiscal space to respond to external shocks), governments should commit to a long-run target for this ratio

14. Exchange Rate & Monetary Policy Contribution to Macroeconomic Stability
Two policies must be discussed together
Choice of exchange rate regime has direct implications for the monetary policy regime
Common currency → no domestic monetary policy
Fixed or heavily managed exchange rate → monetary policy must maintain the exchange rate
Flexible exchange rate → monetary policy independence, but central bank must chose a nominal anchor: inflation or money supply targeting
Key Consideration: Stable nominal target to anchor expectations and maintain macro stability

15. Macroeconomic Policy Challenges in Small States
Fiscal Policy
Large demand for expenditures & transfers (governments play a large role; provide insurance)
Tax collection inefficient (lack economies of scale; heavy reliance on import taxes)
Chronic deficits often result that are not easy to finance (require financial institutions to hold debt)
Monetary financing of deficits undermines exchange rate & monetary policy

16. Macroeconomic Policy Challenges in Small States
Exchange Rate & Monetary Policy
Difficult to conduct an independent monetary policy (thin domestic financial markets; low demand for monetary base; fiscal problems)
Typical policy regimes: Common currencies; currency boards; fixed or heavily managed exchange rate regimes
Import domestic monetary policy from abroad
Lose the nominal exchange rate as a flexible adjustment mechanism; must rely on flexible wages and prices to absorb shocks

17. Monetary Policy Framework
Country
Population (2006)
GDP Billions of USD
GDP per capita
PPP
Exchange rate regime
Monetary Policy Framework
Bahamas
303,770
$6.48
$21,300
Fixed peg to USD
Exchange rate anchor
Barbados
279,912
$5.11
$18,200
Fiji
905,949
$5.50
$6,100
Fixed peg against a basket
Jamaica
2,758,124
$12.71
$4,600
Float
Base money
target
Malta
400,214
$8.12
$20,300
Fixed peg to Euro
Mauritius
1,240,827
$16.72
$13,500
Inflation targeting
Singapore
492,150
$138.6
$30,900
Managed float against a USD, Euro and JPY.

28. Coefficient of variation for Output Growth
Country
1973 – 2004
1973 – 1989
Bahamas
2.80
2.65
1.88
Barbados
2.08
1.73
2.78
Fiji
1.56
2.21
1.05
Jamaica
5.79
-23.54
1.13
Malta
0.83
0.73
0.71
Mauritius
1.30
1.14
0.19
Singapore
0.53
0.44
0.64

29. Coefficient of variation for CPI
Country
1973 – 2005
1973 – 1989
Bahamas
0.72
0.47
0.76
Barbados
1.14
0.85
0.95
Fiji
0.64
0.44
0.59
Jamaica
0.50
0.91
Malta
0.97
1.02
0.32
Mauritius
0.81
0.79
0.37
Singapore
1.58
1.38
0.82

30. Summary of Findings
Prudent fiscal policy seems to be prerequisite for achieving economic resilience and stable growth
Low and stable inflation can be achieved with either a fixed or a managed floating exchange rate
External debt and current account positions become less of a concern if domestic macroeconomic policies are appropriate

31. Concluding Remarks
Economic resilience is an important and useful concept for small states
Macroeconomic stability is critical to economic resilience
Good fiscal, monetary and exchange rate policies can foster macroeconomic stability and “nurture” economic resilience
Financial policies are also important for resilience; strong financial institution and access to global capitals
Despite the challenges small states face, it is in their best interest to adopt best-practice macroeconomic policies

32. Closing Remark - Role of IMF
Given the challenges small states face, the IMF (and other international organizations) should provide technical assistance to them to put in policies that will increase resilience
They should also consider providing access to precautionary lines of credit so that these states can borrow when they are affected by an adverse economic shock