The What, Why, and How of Maintaining Barbados’ Exchange Rate
In any debate about Barbados’ economy, you can expect to hear many opinions about the best way forward, but the one thing that most people agree on is we need to protect our fixed exchange rate, or as economists often call it, the peg.
But what is a fixed exchange rate? Why is having one important for Barbados? And, critically, how do we maintain it?
Fixed or Floating?
Currencies can be either fixed or floating. A country with a floating currency has not tied, or pegged, the value of their currency to another country’s. “What that means is that every day, you can get a different exchange rate,” says Central Bank of Barbados Governor, Cleviston Haynes.
In contrast, a country with a fixed exchange rate regime has tied its currency to another country’s, usually a larger one with a stable economy. In Barbados’ case, we’ve tied the value of our currency to the United States dollar. In doing so, “we’re guaranteeing that once you do a transaction, it’s one US dollar equals two Barbados dollars, every day.”
Barbados isn’t alone in having a fixed exchange rate. Several other countries in the region, including The Bahamas, Belize, and the countries that use the Eastern Caribbean dollar do as well, while the United States, Canada, the United Kingdom, and the European Union have floating currencies.
Why a Fixed Exchange Rate Makes Sense for Barbados
If large countries have currencies with floating exchange rates, wouldn’t it be better for us smaller countries to do so as well?
It is precisely because of our size that many countries in the region have a fixed exchange rate regime. Barbados and these other islands are what economists refer to as small open economies (SOEs), countries that are small in size and/or population that engage in international trade. But while we trade internationally, due to our size, we have no influence over the prices of goods and services. By having our currency tied to one that does have influence, we are able to keep the prices we pay for imports relatively stable.
As for why we’ve chosen to peg our currency to the US dollar – we were previously tied to the pound sterling – Governor Haynes explains. “Many, if not most of our [international] transactions are denominated in the US currency, and the US is a strong international reserve currency.”
Preserving the Peg
It’s not enough for a country to decide to have a fixed exchange rate; it has to be able to maintain it, which Barbados has done for more than 45 years.
The key, says Governor Haynes, is being able to ensure the island consistently has enough international reserves, which are foreign currency assets that Barbados can use to pay for goods and services as needed. Having an adequate level of reserves creates confidence both locally and internationally that the country can meet its obligations. “If you have no foreign exchange, you can’t deliver at that two to one rate.”
As a rule, 12 weeks is considered the benchmark, but more is better, as that creates breathing room when there is a higher than usual demand for foreign exchange, as can happen if oil prices increase significantly; or if something happens that impedes our ability to earn it.
Barbados gets the foreign exchange it needs to build up our international reserves through a number of sectors, including tourism, the international business and financial services (IBFS) sector, physical exports from agriculture, manufacturing, and other industries, and selling professional services abroad. Another option the island has is to borrow from international financial institutions and other lenders. While this is sometimes necessary, Governor Haynes believes the emphasis must be on earning them.
How Do Barbadians Help Safeguard the Peg… And What Happens if We Don’t?
As workers, we can help to ensure that Barbados always has an adequate level of international reserves, and that those reserves are earned rather than borrowed. How? “At the individual level, it is our own productivity which is going to be very important, not only from a price perspective, but also the quality of the service we are able to provide. That really determines whether we as a country can compete internationally.”
And if we don’t maintain that very important stock of international reserves, and by extension preserve the peg? “If we are unable to maintain the peg, the cost of goods becomes more expensive, and your standard of living tends to fall.