Choosing an Exchange Rate Regime: The Challenge for Smaller Industrial Countries

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The perception of market participants seems to be that Norway will not resume a policy resulting in high inflation. The political authorities formulate Norges Bank's mandate for the conduct of monetary policy. The mandate, formulated in the regulation issued in the spring of , states: "The monetary policy to be conducted by Norges Bank shall be aimed at maintaining a stable exchange rate against European currencies, based on the range of the exchange rate maintained since the krone was floated on 10 December In the event of significant changes in the exchange rate, policy instruments will be oriented with a view to returning the exchange rate over time to its initial range.

No fluctuation margins are established, nor is there an appurtenant obligation on Norges Bank to intervene in the foreign exchange market" my italics. The regulation is based on the fact that we have a floating exchange rate. The first sentence means that this is a managed float. Instruments are to be oriented towards maintaining a stable krone exchange rate against European currencies.

Norges Bank chose to define the reference European currencies as the euro from 1 January The last sentence in the regulation distinguishes our system from a fixed exchange rate regime in that no fluctuation margins have been established around a central rate. To the extent this system calls forth associations with a fixed exchange rate regime, the concept initial range should be interpreted as a broad indication of a central rate around which the krone can fluctuate. The second sentence refers to significant changes in the exchange rate in relation to the initial range.

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Significant must be given an economic content. A reasonable interpretation is that exchange rate movements must not influence expectations concerning price and cost inflation to the extent that changes in the exchange rate become self-reinforcing. The expressions with a view to, over time, aimed at and based on also show that Norges Bank has considerable scope for exercising discretion. In exercising this discretion, Norges Bank places emphasis on the fundamental conditions for achieving exchange rate stability over time. Price and cost inflation must be brought down to the level aimed at by the euro countries.

At the same time, monetary policy must not in itself contribute to a deflationary recession. The regulation's requirement with regard to returning the exchange rate to its initial range may - if stretched - imply an element of "parity policy". For example, in a scenario with a sharp and prolonged fall in oil prices, the krone exchange rate may remain outside the initial range for a longer period.

If Norges Bank responds by raising interest rates in order to force the krone back to its initial range, monetary policy could lead to a recession that will undermine confidence in the krone. Similarly, after an appreciation a situation may arise whereby a movement of the exchange rate back to the initial range may require that interest rates be reduced to such a low level that this results in higher inflation.

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However, this would weaken the basis for exchange rate stability over time. Second, international financial flows are affected by two additional macroeconomic risks that are absent within countries: sovereign risk and the use of different currencies. Third, international capital flows imply additional policy challenges for countries as policy-makers face a difficult trade-off among three objectives: monetary policy autonomy, a stable fixed exchange rate, and free capital mobility.

Research has demonstrated that local conditions-political objectives, financial markets, firms, and institutions-decisively influence the operation of these basic macroeconomic logics in actual practice. As a whole, the course emphasizes the importance of domestic institutions for effective macroeconomic policy-making, capacious regulations, credible policy commitment, and attracting and using foreign direct investment efficiently.

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HC: Global Capital and National Institutions-- Crisis and Choice in the International Financial Architecture, focuses on the costs and benefits of international capital and the policies utilized to make it work. The course is composed of three intellectual segments. Career Focus The course is intended for students with who expect to have careers influenced by international trends; careers in global financial management. Educational Objectives The course has been designed to give students an appreciation of the critical role of institutions and policies in affecting patterns of international capital flows and the abilities of government to manage them effectively.

Course Content and Organization HC: Global Capital and National Institutions-- Crisis and Choice in the International Financial Architecture, focuses on the costs and benefits of international capital and the policies utilized to make it work. The module Determinants and Effects of International Capital Flows studies both potential positive and negative effects in host economies of opening up to international capital flows. In particular the cases analyze the effects of capital flows in the development efforts of countries, with an emphasis on FDI which has become the main source of private flows to emerging markets and the policies to attract and maximize FDI's benefits.

In addition, the cases in this first segment explore the effects of international capital flows in the context of financial crises. The second segment of the course, Policies and Strategies for Harnessing the Benefits of Financial Globalization, focuses on the strategies to harness the benefits of financial globalization and minimize potential risks.

The cases cover policies regarding the management of capital inflows using capital controls, the choice of exchange rate regime, and policies associated with the management of sovereign defaults.

The module ends with a discussion of the effects of transfers of capital and debt relief between rich and poor countries. The increase in financial sector activities was driven entirely by the good performance of domestic financial services as activities in the international financial sector declined due to the financial crisis. Construction work expanded largely because of ongoing tourism-related projects. However, the growth in construction moderated compared to the first quarter of , in line with the slower growth in private investment.

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Against this background and in line with the latest forecast of the world economic growth, we expect economic growth in the Netherlands Antilles to slow to 0. For we project the economy to expand by 1. Needless to say that the projected economic slowdown for this year translates into lower activities for the small and medium sized enterprises. Small and medium enterprises are either active in the sectors that are being affected by the slowdown, including the hotels and restaurants sector, the wholesale and retail sector, and the international financial services sector or provide services to these sectors.

The main pressures faced by these enterprises are weak demand, both domestic and foreign, and tighter credit conditions. Given their importance, it is imperative that actions should be taken in order to help the small and medium enterprises survive these times of economic slowdown, and subsequently, benefit of the opportunities the projected economic recovery will offer. Ladies and gentlemen, we are currently in the historic process of the dismantling of the Netherlands Antilles. In the near future, Curacao will become an autonomous country within the Dutch Kingdom.

An autonomous status will provide us with the unique opportunity to address certain economic issues in a more island-specific way and thereby stimulate economic growth. Evidently, this will be beneficial for the business community, including the small and medium sized firms.

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A crucial aspect in this context is macro-economic stability. One of the greatest threats to our macro-economic stability is in my view our vulnerability to external shocks. Our balance of payments has become more susceptible to external shocks with far-reaching implications for the real economy.

The rapidly expanding current account deficit during the last few years, financed by capital inflows from abroad exposes an increasing external vulnerability, which has been masked by the recent inflows of funds related to the debt relief program.

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A sudden reversal of capital flows could deplete our foreign exchange reserves quickly, undermining confidence in our currency. With regard to the monetary system in the new constitutional structure, it has been agreed that the countries of Curacao and Sint Maarten will form a monetary union with one central bank and a common currency. However, the balance of payments vulnerability compels us to consider alternatives, one of which is dollarization.

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Three of the five islands comprising the Netherlands Antilles, i. Moreover, the US dollar is widely accepted in Curacao. Therefore, it would not be such a big step to formally dollarize Curacao and Sint Maarten. Having the dollar as legal tender removes the possibility of a balance of payments crisis with the risk of devaluation.

An economic downturn or reversal of capital flows would not turn into a currency crisis. An immediate benefit from the elimination of currency crises would be a reduction of the country risk premium, consequently lowering interest rates. In other words, the spread between the interest rates of the dollarized economy and the United States is reduced.

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Lower interest rates benefit growth by reducing the cost of credit, encouraging investments. In addition, as a result of dollarization, transaction costs, related to the conversion into foreign currency, are lowered. This would benefit trade, including tourism and foreign direct investments. Due to the perceived currency risk, local financial institutions might be more inclined to invest in foreign assets. In the absence of currency risk, the appetite to invest capital locally might increase. By adopting the US dollar, the financial system becomes more open to international capital flows.

Capital mobility promotes financial intermediation, competition and efficiency among institutions, and promotes confidence in the financial system. It also encourages integration of the domestic financial system with the rest of the world. Although the public finances of Curacao and Sint Maarten are closely monitored by the budget supervisor CFT, dollarization would provide an extra long-term constraint for fiscal policy as it eliminates the possibility of printing money to finance fiscal deficits.