Dual nominal anchors in the Caribbean

Abstract

PurposeThe purpose of this paper is twofold. First, it estimates the sterilization coefficients for several Caribbean countries. Second, it contributes to the literature by providing a conceptual framework for understanding why regional economies with fully pegged exchange rate regimes have not allowed the money supply to be endogenous to capital flows. This paper notes that a high sterilization coefficient plus a de facto pegged exchange rate indicates the existence of dual nominal anchors.Design/methodology/approachThe paper presents a simple theoretical model to explain this phenomenon. The model combines the liquidity preference of commercial banks with an augmented uncovered interest parity equation.FindingsThe econometric evidence presented shows that several Caribbean economies with fixed exchange rate regimes also possess high sterilization coefficients. Given open capital accounts in the various economies, the paper argues that this finding contravenes the money neutrality thesis, which holds that only one nominal anchor can prevail in the long term.Originality/valueThe model emphasizes that the interest rate formation and liquidity preference of oligopolistic commercial banks – the dominant financial institutions in a post‐liberalized setting – prevents counteracting capital movements when monetary policy changes above or along a threshold or bank mark‐up interest rate.