The benefits and costs of exchange rate arrangements: The case of the Eastern Caribbean Currency Union

This dissertation analyses the benefits and costs of exchange arrangements with special focus on the Eastern Caribbean Currency Union (ECCU). In a series of projects I evaluate the some of the reasons for the disparity in the economic performances in the region.; In the first project I examine the macroeconomic adjustment in 15 Caribbean countries. The econometric procedure is based on the work of Blanchard and Quah (1989) and Bayoumi and Eichengreen (1993), in which a structural vector autoregression is used to recover supply and demand shocks. The principal findings are that: (1) the currency union/currency board arrangement increases the ability of the countries in the ECCU to absorb supply shocks; and (2) compared to the other regimes the ECCU results in a lower volatility of demand shocks. These factors help to explain the disparity in economic performance in the region.; In the second project, I examine whether the nominal exchange regime affects the cost of development. The econometric procedure employs the technique of individual generalized least square regressions and pooled seemingly unrelated regression estimates. The model is in the spirit of Bordo and Rockoff (1995). The main finding is that compared to other regimes in the regime, the ECCU is associated with a lower nominal interest rate differential, hence a lower cost of capital.; In the third project I examine the case for monetary union in the wider Caribbean. Monetary union would be successful in circumstances, where the member countries are symmetric in their response to demand and supply shocks as the cost of losing the option to devalue would be low. One measure of symmetry is the degree of convergence. Using the Kalman filter, I derive time-varying parameter estimates in the spirit of Boone (1997). Two convergence hypotheses are examined. The first hypothesis involves convergence between the ECCU and other Caribbean countries. The second hypothesis involves convergence between Trinidad and Tobago and the other Caribbean countries. In both instances the results indicate very little convergence. This suggests that the case for continuing the process of monetary union in the Caribbean is weak.