Central Bank of Barbados to Host a Three-Day Conference on Monetary Policy In Small Very Open Economies

The Central Bank of Barbados will host a three-day conference on Monetary Policy in Small Very Open Economies at the Grande Salle, Tom Adams Financial Centre from December 15 to 17, 2014.

Dr. Tarron Khemraj, the William G. and Marie Selby Associate Professor of Economics at New College of Florida, the Honors College of State University System of Florida, will facilitate the seminar which targets economists and central bankers.

“This seminar examines some basic ideas outside the realm of standard money and banking textbooks that are applicable to Small Very Open Economies (SVOEs) such as those in the Caribbean,” Dr. Khemraj who is the author of the recently published book Money, Banking and Foreign Exchange Market in Emerging Economies and numerous articles in journals from the Caribbean and international noted.

He argues that in most instances the theories and practices meant for the advanced capitalist economies are applied to SVOEs, without considering how peculiar structural features require variation in the received wisdom. For example, the central bank is assumed to possess a benchmark interest rate – as is assumed in the popular Taylor rule reaction function – as its monetary instrument. All mainstream models take it as given that the central bank is in control of a short-term benchmark rate. However, the oligopolistic nature of the market could prevent the central bank from taking full advantage of the short rate given buyers of the sovereign paper might collude to fix the rate. In addition, the conventional view holds that an SVOE cannot have an independent monetary policy if it has a fixed exchange rate (or managed float) and an open capital account.

Moreover, conventional monetary theories tend to focus more on a competitive loanable funds market in which real forces are determining the long-term rate of interest, which tends to be flexible. However, the market for loanable funds is largely dominated by private oligopolistic commercial banks that mark-up the lending rate over the marginal cost of making the loan and the interest rate that could be earned in a foreign risk-free asset. Therefore, long-term interest rates may be administered by private oligopolistic banks instead of being determined in flexible loanable funds market in which the real forces of thrift and investment interact. The loan interest rate might not be very flexible in the short run and would tend to settle at a long-term minimum rate at which point loans and excess liquidity are perfect substitutes.

According to Dr. Khemraj the situation outlined above requires rethinking how monetary policy works in SVOEs. This seminar addresses some of these topics with the hope that empirical studies will address these transmission mechanism issues.

It is hoped that this seminar will help towards identifying new empirical research for future analysis, so that our societies could decipher alternative channels through which monetary policy could determine stability. Attendees will discuss the compensation mechanism, which potentially allows the central bank to have an independent monetary policy and a fixed exchange rate over the long-term. The seminar will also discuss alternative specifications of the central bank’s reaction function.

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