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Mr. Serhan Cevik and Tianle Zhu
Monetary independence is at the core of the macroeconomic policy trilemma stating that an independent monetary policy, a fixed exchange rate and free movement of capital cannot exist at the same time. This study examines the relationship between monetary autonomy and inflation dynamics in a panel of Caribbean countries over the period 1980–2017. The empirical results show that monetary independence is a significant factor in determining inflation, even after controlling for macroeconomic developments. In other words, greater monetary policy independence, measured as a country’s ability to conduct its own monetary policy for domestic purposes independent of external monetary influences, leads to lower consumer price inflation. This relationship—robust to alternative specifications and estimation methodologies—has clear policy implications, especially for countries that maintain pegged exchange rates relative to the U.S. dollar with a critical bearing on monetary autonomy.
Mr. Serhan Cevik and Tianle Zhu

Monetary independence is at the core of the macroeconomic policy trilemma stating that an independent monetary policy, a fixed exchange rate and free movement of capital cannot exist at the same time. This study examines the relationship between monetary autonomy and inflation dynamics in a panel of Caribbean countries over the period 1980–2017. The empirical results show that monetary independence is a significant factor in determining inflation, even after controlling for macroeconomic developments. In other words, greater monetary policy independence, measured as a country’s ability to conduct its own monetary policy for domestic purposes independent of external monetary influences, leads to lower consumer price inflation. This relationship—robust to alternative specifications and estimation methodologies—has clear policy implications, especially for countries that maintain pegged exchange rates relative to the U.S. dollar with a critical bearing on monetary autonomy.

International Monetary Fund. Western Hemisphere Dept.

the rise in inflation was widespread across the region, there has been large variation in actual inflation rates both in Latin America and in the Caribbean ( Box 3.1 ). Box 3.1. Inflation Pressures in the Caribbean Inflation in the Caribbean increased to 9 percent at end-2007, from 6 percent in 2006 . There was, however, significant variability across countries, with 2007 inflation as low as 2.1 percent in St. Kitts and Nevis and as high as 17 percent in Jamaica. In most cases, the currencies of Caribbean countries are pegged to the U.S. dollar, and the

International Monetary Fund. Western Hemisphere Dept.

policy in Jamaica has led to a reduction in consumer price inflation from 19 percent in September 2005 to under 6 percent by end-2006. Similarly, inflation in the Dominican Republic, which accelerated sharply in the wake of the banking crisis in 2002–03, was reversed once the authorities regained control over monetary aggregates. Inflation has, however, remained an issue in Trinidad and Tobago, where the positive terms of trade shock and rapid growth of public investment have led to the emergence of capacity constraints. On balance, average inflation in the Caribbean

International Monetary Fund. Western Hemisphere Dept.

4 of this REO. Real GDP Growth in the Caribbean (Percent change) Sources: National authorities; and IMF staff calculations. 1/ Simple average. 2/ Includes ECCU, Bahamas, Jamaica, Barbados, and Belize. Contribution to Overall Inflation in the Caribbean 1/ (Annual percent change) Sources: National authorities; and IMF staff calculations. 1/ Unweighted inflation across The Bahamas, Barbados, Belize, ECCU, Guyana, Jamaica, Suriname, and Trinidad and Tobago. Note: This box was prepared by Trevor Alleyne. 1 The net

International Monetary Fund. Western Hemisphere Dept.

inflation effects, the lagged change in the remittances-to-GDP ratio is found to be associated with somewhat higher inflation in the Caribbean and CAPDR ( Table 5.2 ). This result may also reflect the prevalence of fixed or stabilized exchange rate regimes in many countries in these subregions. The contemporaneous effect of the remittances-to-GDP ratio on inflation appears to be significant only for the Caribbean. The Perils of Dependence on Remittances Extensive reliance on remittances can be risky, especially when most migrants reside in a single country. If a