## _wp1467

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---

### I. Introduction and context
- Caribbean countries have been largely successful in bringing annual inflation down to single digits in recent years.
- Growth rates have been disappointing despite fiscal stimulus; absent higher growth, the fiscal position may not be sustainable.
- Deteriorating public finances have increased financing needs and the debt burden and constrained the ability to pursue countercyclical policies.
- Caribbean countries are small open economies highly dependent on tourism receipts, exposing them to excessive demand variability from external shocks.
- Structural impediments and financing constraints limit policymakers’ ability to smooth the outcome of demand variability on economic performance.
- The paper traces cyclical fluctuations across a sample of fifteen Caribbean countries.

### II. Sample, key statistics, and macroeconomic overview
- Sample period: 1980–2010.
- Countries under investigation: Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Dominican Republic, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent, Suriname, and Trinidad and Tobago.
- Average real GDP growth (1980–2010): lowest in Haiti, 0.64%; highest in Belize, 5.4%.
- Volatility of real growth (standard deviation): lowest in St. Kitts and Nevis, 2.5 percent; highest in Suriname, 5.9 percent.
- Output in Caribbean countries is, on average, about 1.6 times as variable as output in the United States.
- Inflation (GDP deflator) over 1980–2010: ranges from 2.8 percent in Belize to 25.9 percent in Suriname.
- Inflation variability: highest in Suriname, 39 percent; lowest in The Bahamas, 2.8 percent.
- Cross-country average correlation coefficient between real growth and price inflation: -0.57 (negative and statistically significant).

### III. Theoretical background (asymmetry mechanisms)
- Aggregate demand shocks assumed symmetric (zero mean, constant variance) but institutional/structural rigidities can generate asymmetric real and nominal responses.
- Mechanisms discussed:
  - Nominal-wage indexation and downward wage rigidity: cost-of-living adjustments raise wages in booms; employers resist downward wage adjustments in recessions.
  - Menu costs and price-adjustment frictions: higher trend inflation raises incentives to increase prices during booms; producers resist paying menu costs to lower prices in recessions.
  - Time-dependent pricing, sticky plans, sticky information, and sticky relative prices induce faster upward adjustment and rigidity to downward adjustment.
- Implication: demand variability can increase trend price inflation and decrease trend real output growth on average.

### IV. Econometric identification and approach
- Dependent variables in first-difference form: real output (log y), GDP deflator (Dp), private consumption Dc, private investment Dv, exports Dx, imports Dim, trade balance Dtbal.
- Aggregate demand proxy: logarithm of nominal GDP (n); shocks decomposed into anticipated (forecasted) and unanticipated (residual) components.
- Controls for supply shocks: dummy variables for years of natural disasters and the energy price (o).
- Positive and negative shocks constructed as pos = (shock + |shock|)/2 and neg = (shock - |shock|)/2.
- Forecasted demand formed by regressing nominal GDP growth on lags of real growth, price inflation, money supply growth, government spending growth, change in real effective exchange rate, change in oil price, and disaster dummies; residual is the unanticipated shock (symmetric distribution).
- Estimation method: joint estimation (3SLS) with instruments (two lags of log first differences of real growth, price inflation, energy price, real effective exchange rate, government spending, and money supply); adjustment for AR(1) error where present.

### V. Time-series results — real output growth
- Expansionary demand shocks significantly stimulate real output growth in: The Bahamas, Jamaica, St. Kitts and Nevis, and St. Vincent.
  - This indicates capacity to expand supply during booms in these countries.
- Contractionary demand shocks reduce real output growth significantly in all but four countries: Dominican Republic, Guyana, Haiti, and Jamaica.
- Statistically significant negative asymmetry (output contraction exceeds expansion under symmetric demand shocks) found in: Antigua and Barbuda, Barbados, Belize, Dominica, Grenada, St. Lucia, Suriname, and Trinidad and Tobago.
- No country in the group shows a statistically significant case where expansion exceeds contraction; in The Bahamas, Dominican Republic, Guyana, Haiti, Jamaica, St. Kitts and Nevis, and St. Vincent output fluctuations appear symmetric (neutral effect of demand variability on trend real growth).

### VI. Time-series results — price inflation
- Pervasive and significant positive response of price inflation to expansionary demand shocks across many countries, indicating fast upward price adjustment and capacity constraints on real expansion during booms.
- Limited significant positive response or negative response of inflation to contractionary demand shocks, indicating downward rigidity of prices and exacerbating output contraction in downturns.
- Difference in inflation response to positive vs. negative demand shocks (positive and significant) observed in: Antigua and Barbuda, Barbados, Belize, Dominica, Grenada, St. Lucia, Suriname, and Trinidad and Tobago — implying an inflationary bias from demand variability.
- Suriname has the highest trend inflation across the sample; asymmetric adjustment to demand variability may have further exacerbated this inflationary bias.

### VII. Exchange rate variability — cross-country evidence and channels
- Real exchange rate variability measured by the standard deviation of movements around steady-state equilibrium.
- Cross-section (32-country Latin America and Caribbean) findings:
  - Exchange rate variability increases trend price inflation significantly across countries.
  - Exchange rate variability significantly reduces trend real growth.
  - Effects on trend inflation and trend real growth are exacerbated in countries with floating exchange rate regimes.
  - Exchange rate variability accelerates import growth significantly; effect is exacerbated under floating regimes.
  - For consumption, investment, exports, trade balance, and current account balance: asymmetry is not pronounced across the full sample to yield significant trend effects; however, in floating-regime countries, trends of consumption, investment and exports are higher relative to pegged-regime countries.
- Exchange rate variability increases aggregate uncertainty and the variability of price inflation, real growth, consumption growth, export growth, and import growth across countries.
  - Countries with floating exchange rate systems exhibit even higher variability of price inflation, private consumption, and imports compared to pegged systems.
- Policy implication: "Aligning the real exchange rate with underlying fundamentals would help stem the variability attributed to movements in relative prices and bilateral exchange rates with major trading partners and the associated cyclical biases in the transmission of these shocks to the macro-economy."

### VIII. Determinants of asymmetry (cross-country evidence)
- Analysis uses time-series parameter estimates from 32 countries in Latin America and the Caribbean.
- Sticky-price and sticky-wage theories reviewed.
- Cross-country regression evidence does not support endogeneity of asymmetry to trend inflation and/or demand variability:
  - Across countries, higher trend inflation significantly increases output expansion relative to contraction (suggesting stronger anti-inflation efforts moderate contractionary effects).
  - An increase in demand variability increases incentives to moderate output contraction relative to expansion.
  - There is a negative relationship between upward price flexibility and higher demand variability across countries.
- Conclusion: determinants of asymmetric price flexibility are likely structural rigidities in labor and product markets rather than endogenous responses to trend inflation or demand variability.

### IX. Asymmetry in specific demand components (highlights from Box 1)
- Private consumption:
  - Boom: growth increases significantly and correlates with higher price inflation in Dominica, Dominican Republic, Guyana, Haiti, Jamaica, St. Lucia, Suriname, and Trinidad and Tobago.
  - Recession: consumption growth decreases significantly and correlates with output contraction in Barbados, Belize, St. Kitts and Nevis, St. Lucia, and Suriname.
  - Recession: consumption growth decreases significantly and correlates with price deflation in Dominican Republic, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, and Suriname.
  - In Barbados, the reduction in consumption growth during a recession exceeds the increase during a boom.
  - In Guyana, the increase during a boom dominates the reduction during a recession.
- Private investment:
  - Boom: investment growth increases significantly and correlates with higher price inflation in Dominica.
  - Recession: investment growth decreases significantly and correlates with larger output contraction in Barbados, Belize, and Suriname.
- Exports and imports:
  - Export growth increases in booms and decreases in recessions with country-specific effects on inflation and output.
  - During booms, import growth increases significantly and correlates with higher price inflation in Antigua and Barbuda, Grenada, St. Kitts and Nevis, and Suriname.
  - Trade balance: during booms, import increases can dominate export increases (significant reduction in trade balance in Antigua and Barbuda and Grenada); during recessions, export reductions can dominate import reductions (deterioration in trade balance in Antigua and Barbuda).

### X. Summary of substantive findings and implications
- Majority of Caribbean countries exhibit asymmetry: contractionary shocks are mostly absorbed in output (output contraction exceeds expansion), while expansionary shocks are absorbed more rapidly in prices (upward price flexibility).
- Asymmetry produces two biases from demand variability:
  - Inflationary bias: demand variability tends to raise trend price inflation where upward price flexibility dominates.
  - Contractionary bias: demand variability tends to lower trend real output growth where output contracts more in downturns than it expands in booms.
- Nominal flexibility via floating exchange rates amplifies adverse trend effects (higher inflation, lower trend growth) and increases variability/uncertainty in macroeconomic variables.
- Aligning the real exchange rate with underlying fundamentals would help reduce real-exchange-rate variability and associated cyclical biases.

### XI. Policy recommendations
- Two major policy tracks:
  1. Address structural and institutional rigidities
     - Carefully analyze institutional and structural rigidities underlying capacity constraints during expansionary demand shocks and nominal rigidity during contractionary shocks.
     - Review constraints to factor mobility and institutions for price adjustments to identify factors responsible for asymmetry.
     - Establish priorities to reduce structural rigidities in factor and product markets that cause downward biases on growth and upward biases on inflation.
  2. Smooth demand variability and expand countercyclical policy space
     - Reduce procyclical macroeconomic policies that amplify external shocks (e.g., additional fiscal spending during booms that accelerates price inflation; cuts in government spending during recessions that exacerbate contractionary effects).
     - Increase fiscal space to enable necessary countercyclical policies to mitigate external shocks and smooth asymmetric effects from demand variability.
     - Focus policy priorities on reforming public finances and building necessary buffers for policy interventions to reduce vulnerability of Caribbean economies to external shocks.

### XII. Appendix highlights — averages by exchange rate system
- Pegged:
  - Trend Inflation: 0.12
  - Trend Growth: 0.04
  - Avg. Con. Growth: 0.13
  - Avg. Inv. Growth: 0.08
  - Avg. Exp. Growth: 0.14
  - Avg. Imp. Growth: 0.14
  - Output Growth: 0.21
  - Price Variability: 0.04
  - Consumption Variability: 0.23
  - Investment Variability: 0.95
  - Export Variability: 0.24
  - Import Variability: 0.22
- Floating:
  - Trend Inflation: 0.24
  - Trend Growth: 0.03
  - Avg. Con. Growth: 0.25
  - Avg. Inv. Growth: 0.25
  - Avg. Exp. Growth: 0.27
  - Avg. Imp. Growth: 0.26
  - Output Growth: 0.36
  - Price Variability: 0.04
  - Consumption Variability: 0.40
  - Investment Variability: 0.88
  - Export Variability: 0.36
  - Import Variability: 0.34

- Country classification by exchange rate regime (as listed in the source):
  - Pegged: Antigua & Barbuda; Argentina; Bahamas, The; Barbados; Belize; Dominica; Dominican Republic; Ecuador; El Salvador; Grenada; Honduras; Nicaragua; Panama; St. Kitts & Nevis; St. Lucia; St. Vincent & the Grenadines; Trinidad & Tobago
  - Floating: Bolivia; Brazil 1/; Chile 1/; Colombia 1/; Costa Rica; Guatemala 1/; Guyana; Haiti; Jamaica; Mexico 1/; Paraguay; Peru 1/; Suriname; Uruguay; Venezuela

- Caribbean: Wage Determination Flexibility (World Economic Forum, Global Competitiveness Report 2012-2013) — selected scores:
  - Barbados: 4.798
  - Guyana: 5.347
  - Jamaica: 4.984
  - Suriname: 5.076
  - Trinidad and Tobago: 4.2119

*Source: _wp1467*

### References .............................................................................................................

### _wp1467 - References

### I. Introduction and context
- Caribbean countries have been largely successful in bringing annual inflation down to single digits in recent years.
- Growth rates have been disappointing despite fiscal stimulus; absent higher growth, the fiscal position may not be sustainable (see Sahay (2006)).
- Deteriorating public finances have increased financing needs and the debt burden and constrained the ability to pursue countercyclical policies to weather increased vulnerability to external shocks.
- Caribbean countries are small open economies highly dependent on tourism receipts; this exposes them to excessive demand variability from external shocks.
- Structural impediments and financing constraints limit policymakers’ ability to smooth the outcome of demand variability on economic performance.
- The paper traces cyclical fluctuations across a sample of fifteen Caribbean countries.

### II. Analytical framework and theoretical background
- Framework assumptions:
  - Very small open economies are presumed to be price takers.
  - Capacity constraints caused by scarcity of resources and import rationing are likely to render the aggregate supply curve steeper and accelerate price adjustments in the face of expansionary demand shocks.
  - Institutional rigidities, such as an inflexible labor market, are likely to limit the speed of nominal adjustments in the face of contractionary demand shocks, necessitating a large output and employment contraction during cyclical downturns.
- Sources of demand-side fluctuations:
  - Domestic factors or policies, including monetary or fiscal policies.
  - External factors, such as those affecting flows of remittances and/or other determinants of the external position.
- Fiscal responses can be pro-cyclical when financial resources are tight, exacerbating demand variability and limiting fiscal space for countercyclical policy.

### III. Empirical focus and contribution
- The paper studies asymmetry in the response of real growth and price inflation to frequent and large demand shocks over the business cycle for small states similar to the Caribbean sample.
- Theoretical literature referenced:
  - Asymmetric price adjustments and “menu costs” (Ball and Mankiw (1994)).
  - Labor market rigidity explanations (Gray (1978)).
  - Empirical tests using advanced and developed country data (Kandil (2008)).
- The evidence and implications of asymmetry have not been investigated for small states like the Caribbean sample prior to this analysis.

### IV. Main findings
- The majority of the Caribbean countries are characterized by pronounced asymmetric responses to frequent demand variability.
  - During demand expansions: inflation accelerates while the real output response is moderate.
  - During demand contractions: structural and institutional rigidities exacerbate the drop in real output growth with only a small deceleration in inflation.

### V. Policy implications and recommendations
- Address structural rigidities that:
  - Constrain capacity during an economic boom.
  - Hamper flexible nominal adjustments that would moderate output contraction during cyclical downturns.
- Avoid pro-cyclical policies that accentuate demand shocks and exacerbate:
  - The upward bias on inflation during expansions.
  - The downward bias on real growth during contractions.

### VI. Paper structure (outline)
- Section II: Overview of macroeconomic developments in the fifteen Caribbean countries, focusing on output growth and inflation.
- Section III: Theoretical background for factors in the product and labor markets that underlie asymmetric responses to aggregate demand shocks.
- Section IV: Empirical models and results.
- Section V: Time-series analysis.
- Section VI: [content continues beyond provided excerpt]

*Source: _wp1467 - References*

### conclusion and policy implications.

### _wp1467 - conclusion and policy implications.

### Overview of macroeconomic developments (sample and key statistics)
- Sample period: 1980–2010.
- Countries under investigation: Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Dominican Republic, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent, Suriname, and Trinidad and Tobago.
- Average real GDP growth (1980–2010): lowest in Haiti, 0.64%; highest in Belize, 5.4%.
- Volatility of real growth (standard deviation): lowest in St. Kitts and Nevis, 2.5 percent; highest in Suriname, 5.9 percent.
- Output in Caribbean countries is, on average, about 1.6 times as variable as output in the United States.
- Inflation (GDP deflator) over 1980–2010: ranges from 2.8 percent in Belize to 25.9 percent in Suriname.
- Inflation variability: highest in Suriname, 39 percent; lowest in The Bahamas, 2.8 percent.
- Cross-country average correlation coefficient between real growth and price inflation: -0.57 (negative and statistically significant).

### Theoretical background (asymmetry mechanisms)
- Aggregate demand shocks assumed symmetric (zero mean, constant variance) but institutional/structural rigidities can generate asymmetric real and nominal responses:
  - Nominal-wage indexation and downward wage rigidity: cost-of-living adjustments raise wages in booms; employers resist downward wage adjustments in recessions.
  - Menu costs and price-adjustment frictions: higher trend inflation raises incentives to increase prices during booms; producers resist paying menu costs to lower prices in recessions.
  - Time-dependent pricing, sticky plans, sticky information, and sticky relative prices can all induce faster upward adjustment and rigidity to downward adjustment.
- Implication of asymmetry: demand variability can increase trend price inflation and decrease trend real output growth, on average, over time.

### Econometric approach (identification and model)
- Dependent variables analyzed in first-difference form: real output (log y), GDP deflator (Dp), and specific demand variables (private consumption Dc, private investment Dv, exports Dx, imports Dim, trade balance Dtbal).
- Aggregate demand proxy: logarithm of nominal GDP (n); shocks decomposed into anticipated (forecasted) and unanticipated (residual) components.
- Controls for supply shocks: dummy variables for years of natural disasters and the energy price (o).
- Positive and negative shocks constructed as pos = (shock + |shock|)/2 and neg = (shock - |shock|)/2 following Cover (1992).
- Forecasted demand formed by regressing nominal GDP growth on lags of real growth, price inflation, money supply growth, government spending growth, change in real effective exchange rate, change in oil price, and disaster dummies; residual is the unanticipated shock (symmetric distribution).
- Estimation method: joint estimation (3SLS) with instruments (two lags of log first differences of real growth, price inflation, energy price, real effective exchange rate, government spending, and money supply); adjustment for AR(1) error where present.

### Time-series results — real output growth
- Expansionary demand shocks significantly stimulate real output growth in: The Bahamas, Jamaica, St. Kitts and Nevis, and St. Vincent.
  - Positive and statistically significant effects of expansionary shocks indicate capacity to expand supply during booms in these countries.
- Contractionary demand shocks reduce real output growth significantly in all but four countries: Dominican Republic, Guyana, Haiti, and Jamaica.
- Statistically significant negative asymmetry (output contraction exceeds expansion under symmetric demand shocks) found in: Antigua and Barbuda, Barbados, Belize, Dominica, Grenada, St. Lucia, Suriname, and Trinidad and Tobago.
- No country in the group shows a statistically significant case where expansion exceeds contraction; in The Bahamas, Dominican Republic, Guyana, Haiti, Jamaica, St. Kitts and Nevis, and St. Vincent output fluctuations appear symmetric (neutral effect of demand variability on trend real growth).

### Time-series results — price inflation
- Pervasive and significant positive response of price inflation to expansionary demand shocks across many countries, indicating fast upward price adjustment and capacity constraints on real expansion during booms.
- Limited significant positive response or negative response of inflation to contractionary demand shocks, indicating downward rigidity of prices and exacerbating output contraction in downturns.
- Difference in inflation response to positive vs. negative demand shocks (positive and significant) observed in: Antigua and Barbuda, Barbados, Belize, Dominica, Grenada, St. Lucia, Suriname, and Trinidad and Tobago — implying an inflationary bias from demand variability.
- Suriname noted to have the highest trend inflation across the sample; asymmetric adjustment to demand variability may have further exacerbated this inflationary bias.

### Exchange rate variability — cross-country evidence and channels
- Real exchange rate variability measured by the standard deviation of movements around steady-state equilibrium.
- Cross-section (32-country Latin America and Caribbean) findings:
  - Exchange rate variability increases trend price inflation significantly across countries.
  - Exchange rate variability significantly reduces trend real growth (dominant contractionary effect).
  - Effects of exchange rate variability on trend inflation and trend real growth are exacerbated in countries with floating exchange rate regimes (nominal flexibility amplifies transmission).
  - Exchange rate variability accelerates import growth significantly across countries; effect is exacerbated under floating regimes (nominal flexibility supports higher demand for imports).
  - For consumption, investment, exports, trade balance, and current account balance: asymmetry is not pronounced across the full sample to yield significant trend effects; however, in floating-regime countries, trends of consumption, investment and exports are higher relative to pegged-regime countries (nominal flexibility increases competitiveness, facilitating higher trend export growth and higher trend consumption and investment).
- Exchange rate variability increases aggregate uncertainty and the variability of price inflation, real growth, consumption growth, export growth, and import growth across countries.
  - Countries with floating exchange rate systems exhibit even higher variability of price inflation, private consumption, and imports compared to pegged systems.
- Policy implication emphasized in text: "Aligning the real exchange rate with underlying fundamentals would help stem the variability attributed to movements in relative prices and bilateral exchange rates with major trading partners and the associated cyclical biases in the transmission of these shocks to the macro-economy."

### Summary of substantive findings and policy-relevant inferences
- Evidence of asymmetric allocation of aggregate demand shocks across many Caribbean countries: contractionary shocks are mostly absorbed in output (output contraction exceeds expansion), while expansionary shocks are more rapidly absorbed in prices (upward price flexibility).
- Asymmetry produces two biases from demand variability:
  - Inflationary bias: demand variability tends to raise trend price inflation where upward price flexibility dominates.
  - Contractionary bias: demand variability tends to lower trend real output growth where output contracts more in downturns than it expands in booms.
- Nominal flexibility via floating exchange rates amplifies both the adverse trend effects (higher inflation, lower trend growth) and higher variability/uncertainty in macroeconomic variables.
- Policy guidance from the analysis:
  - Manage expectations and limit adverse effects of exchange rate deviations from steady-state equilibrium.
  - Align the real exchange rate with underlying fundamentals to help reduce real-exchange-rate variability and associated cyclical biases in transmission to the macro-economy.
  - Recognize that nominal flexibility can increase competitiveness and trend exports in some cases but also exacerbates aggregate uncertainty and inflationary/contractionary biases when demand variability is high.

*Source: _wp1467 - conclusion and policy implications.*

### Appendix Table contrasts average indicators across countries based on the exchange rate system. Classification

### _wp1467 - Appendix Table contrasts average indicators across countries based on the exchange rate system. Classification

### Determinants of Asymmetry
- The analysis uses time-series parameter estimates from a larger country sample: 32 countries in Latin America and the Caribbean (LAC).
- Theoretical channels reviewed:
  - Sticky-price explanation: higher incentives to adjust prices upward relative to downward in countries with a history of high inflation.
  - Sticky-wage explanation: higher incentives to adjust wages upward in countries with high trend inflation and/or higher aggregate uncertainty; wages likely sticky-downward in such environments.
- Cross-country regression evidence (reference: Table 4) does not support the theory’s implications that asymmetry is endogenous to trend inflation and/or demand variability.
  - Across countries, higher trend inflation significantly increases output expansion relative to contraction, suggesting stronger anti-inflation efforts that moderate contractionary effects of demand shocks on real growth.
  - An increase in demand variability across countries increases incentives to moderate output contraction relative to expansion.
  - There is a negative relationship between upward price flexibility and higher demand variability across countries.
- Conclusion on determinants:
  - Empirical evidence rejects endogeneity of asymmetric price flexibility with respect to trend price inflation and/or demand variability across countries.
  - Determinants of asymmetric price flexibility are likely structural rigidities in labor and product markets, constraining capacity during booms and downward adjustments in inflation during downturns.
  - The paper highlights the need for future research to unveil structural and institutional impediments, particularly in small Caribbean countries.

### Implications of Asymmetry
- Demand variability alone does not differentiate asymmetry in output and price adjustments during expansions and contractions.
- Structural and institutional constraints determine how demand variability is allocated between price inflation and output growth over economic cycles.
- Asymmetric allocations imply:
  - Symmetric demand shocks can create an inflationary bias and lower real growth as demand variability increases across countries.
- Cross-country regression findings (reference: Table 5):
  - An increase in demand variability (higher probability of realizing positive and negative shocks) increases trend price inflation; evidence is positive and significant across countries.
  - Higher demand variability moderates real output growth; the parameter estimate is negative, although insignificant across countries.

### Asymmetry in Specific Demand Components
- Evidence (reference: Table 6 and Box 1) on components of aggregate demand:
  - Private consumption increases significantly during economic booms, which can further accelerate price inflation in some countries.
  - Significant reduction in private consumption during recessions can exacerbate real output contraction in other countries.
  - Asymmetric cyclical fluctuations of private investment are more pronounced than for private consumption, further exacerbating inflationary effects and output contraction over the business cycle.
  - Cyclicality in exports and imports tends to cancel out during booms and recessions, moderating cyclical fluctuations in the trade balance.

### Summary and Conclusion
- The empirical model distinguishes responses to positive and negative demand shocks and investigates asymmetry in allocation between real output growth and price inflation.
- Key findings:
  - The majority of Caribbean countries exhibit asymmetry in the response of output growth and price inflation to equal-size expansionary and contractionary demand shocks.
  - Asymmetry typically indicates capacity constraints during expansionary demand shocks relative to contractionary shocks.
  - Relative to trend, output contraction exceeds expansion and price inflation exceeds deflation over the business cycle.
  - Demand variability generates a negative growth bias and a positive inflation bias, on average, over time.
  - Variability of the real exchange rate, relative price variability, and bilateral movements in nominal exchange rates with respect to major trading partners exacerbate demand variability and potential cyclical biases associated with asymmetric adjustments.
  - These channels are more pronounced in countries with floating exchange rate systems, where nominal flexibility exacerbates transmission of external shocks given limited scope for countercyclical policies.
  - Aligning the real exchange rate with underlying fundamentals would help stem uncertainty and potential adverse effects from frequent exchange rate variability around its equilibrium.

### Policy recommendations
- Two major policy tracks:
  1. Address structural and institutional rigidities
     - Carefully analyze institutional and structural rigidities underlying capacity constraints during expansionary demand shocks and nominal rigidity during contractionary shocks.
     - Review constraints to factor mobility and institutions for price adjustments to identify factors responsible for asymmetry.
     - Establish priorities to reduce structural rigidities in factor and product markets that cause downward biases on growth and upward biases on inflation.
  2. Smooth demand variability and expand countercyclical policy space
     - Reduce procyclical macroeconomic policies that amplify external shocks (e.g., additional fiscal spending during booms that accelerates price inflation; cuts in government spending during recessions that exacerbate contractionary effects).
     - Increase fiscal space to enable necessary countercyclical policies to mitigate external shocks and smooth asymmetric effects from demand variability.
     - Focus policy priorities on reforming public finances and building necessary buffers for policy interventions to reduce vulnerability of Caribbean economies to external shocks.

*Source: _wp1467 - Appendix Table contrasts average indicators across countries based on the exchange rate system. Classification*

### Box 1. Asymmetry in the Behavior of Specific Demand Components

### Box 1. Asymmetry in the Behavior of Specific Demand Components

### Private Consumption
- During a boom, private consumption growth increases significantly and correlates with higher price inflation in Dominica, Dominican Republic, Guyana, Haiti, Jamaica, St. Lucia, Suriname, and Trinidad and Tobago.
- During a recession, private consumption growth decreases significantly and correlates with output contraction in Barbados, Belize, St. Kitts and Nevis, St. Lucia, and Suriname.
- During a recession, private consumption growth decreases significantly and correlates with price deflation in Dominican Republic, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, and Suriname.
- In Barbados, the reduction in consumption growth during a recession exceeds the increase during a boom.
- In Guyana, the increase in private consumption growth during a boom dominates the reduction during a recession.

### Private Investment
- During a boom, private investment growth increases significantly and correlates with higher price inflation in Dominica.
- During a recession, private investment growth decreases significantly and correlates with larger output contraction in Barbados, Belize, and Suriname.

### Exports
- During a boom, export growth increases significantly and correlates with higher price inflation in Barbados.
- During a recession, export growth decreases significantly and correlates with larger output contraction in Belize, Dominica, Guyana, St. Lucia, and Trinidad and Tobago.

### Imports
- During a boom, import growth increases significantly and correlates with higher price inflation in Antigua and Barbuda, Grenada, St. Kitts and Nevis, and Suriname.
- During a recession, import growth decreases significantly and correlates with larger output contraction in Guyana and St. Lucia.

### Trade Balance
- During a boom, the increase in imports dominates the increase in exports, resulting in significant reduction in the trade balance in Antigua and Barbuda and in Grenada.
- During a recession, the reduction in exports dominates the reduction in imports, resulting in significant deterioration in the trade balance in Antigua and Barbuda.

### Notes on Estimation and Significance (as presented)
- EDn: Anticipated aggregate demand growth.
- Posn: Expansionary shocks to aggregate demand during a boom.
- Negn: Contractionary shocks to aggregate demand during a recession.
- Asyem: difference in the response to expansionary and contractionary shocks.
- Coefficients measure the response of each variable to demand shifts.
- Bracketed magnitudes are t-statistics, where * and ** denote statistical significance at the 5 and 10 percent levels.

### Annex 1 — Data Definition and Sources (items 1–17)
- 1. GDP: Gross domestic product, current prices, WEO, NGDP.
- 2. Real GDP: Gross domestic product, constant prices, WEO, NGDP_R.
- 3. Consumer Price Index: WEO, PCPI.
- 4. Money: Broad Money, WEO, FMB.
- 5. Private Consumption: Private consumption expenditure, current prices, WEO, NCP.
- 6. Private Investment: Gross private capital formation, current prices, WEO, NIP.
- 7. Private Fixed Investment: Gross private fixed capital formation, current prices, WEO, NFIP.
- 8. Total Investment: Gross fixed capital formation, current prices, WEO, NFI.
- 9. Exports: Exports of goods and services, current prices, WEO, NX.
- 10. Imports: Imports of goods and services, current prices, WEO, NM.
- 11. Trade Balance: Exports minus imports of goods and services.
- 12. Current Account Balance: WEO BCA.
- 13. Government Spending: General government total expenditure and net lending, WEO, GGENL.
- 14. Exchange Rate: Real effective exchange rate, the real price of domestic currency with respect to currencies of major trading partners, WEO, reer.
- 15. Caribbean GDP: Sum of gross domestic product, current prices, U.S. dollars, WNGDPD.
- 16. U.S. GDP: Gross domestic product, current prices, U.S. dollar, W111NGDPD.
- 17. Interest Rate: various representatives of interest rates as follows:
  - Discount Rate: IFS, 60..ZF
  - Money Market Rate: IFS, 60..BZF
  - Treasury Bill Rate: IFS, 60..CZF
  - Savings Rate: IFS, 60K..ZF
  - Deposit Rate: IFS, 60L..ZF
  - Lending Rate: IFS, 60P..ZF
- Data are available from World Economic Outlook, WEO, or International Financial Statistics, IFS, available from the IMF.

*Source: _wp1467 - Box 1. Asymmetry in the Behavior of Specific Demand Components*

### Appendix Table Averages of Economic Indicators across Countries based on Exchange Rage Regime

### Appendix Table Averages of Economic Indicators across Countries based on Exchange Rage Regime

### Averages by Exchange Rate System
- Exchange Rate System: Pegged
  - Trend Inflation: 0.12
  - Trend Growth: 0.04
  - Avg. Con. Growth: 0.13
  - Avg. Inv. Growth: 0.08
  - Avg. Exp. Growth: 0.14
  - Avg. Imp. Growth: 0.14
  - Output Growth: 0.21
  - Price Variability: 0.04
  - Consumption Variability: 0.23
  - Investment Variability: 0.95
  - Export Variability: 0.24
  - Import Variability: 0.22

- Exchange Rate System: Floating
  - Trend Inflation: 0.24
  - Trend Growth: 0.03
  - Avg. Con. Growth: 0.25
  - Avg. Inv. Growth: 0.25
  - Avg. Exp. Growth: 0.27
  - Avg. Imp. Growth: 0.26
  - Output Growth: 0.36
  - Price Variability: 0.04
  - Consumption Variability: 0.40
  - Investment Variability: 0.88
  - Export Variability: 0.36
  - Import Variability: 0.34

- Note: 1/ Countries that follow inflation targeting.

### Country Lists (by Exchange Rate Regime) — as listed in the source
- Pegged: Antigua & Barbuda; Argentina; Bahamas, The; Barbados; Belize; Dominica; Dominican Republic; Ecuador; El Salvador; Grenada; Honduras; Nicaragua; Panama; St. Kitts & Nevis; St. Lucia; St. Vincent & the Grenadines; Trinidad & Tobago
- Floating: Bolivia; Brazil 1/; Chile 1/; Colombia 1/; Costa Rica; Guatemala 1/; Guyana; Haiti; Jamaica; Mexico 1/; Paraguay; Peru 1/; Suriname; Uruguay; Venezuela

### Caribbean: Wage Determination Flexibility (World Economic Forum, Global Competitiveness Report 2012-2013)
- Score (1-7) and Rank (out of 144) — selected entries as listed:
  - Barbados: 4.798
  - Guyana: 5.347
  - Jamaica: 4.984
  - Suriname: 5.076
  - Trinidad and Tobago: 4.2119

*Source: Appendix Table Averages of Economic Indicators across Countries based on Exchange Rage Regime (from _wp1467).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2014/_wp1467.pdf_