This paper proposes an approach to macroeconomic policy which equips the authorities in small, open, financially-integrated economies (SOFIEs)2 to target the exchange rate by influencing the volumes of trade in goods and services to achieve equilibrium at the target rate. This is achieved by the use of fiscal policy: the authorities may adjust the size of the fiscal deficit and how it is financed to contain the level of aggregate expenditure in the economy, and the demand for imports that flows from that expenditure.
This paper was prepared for the Handbook of Small States - Economic, Social and Environmental Issues (Routledge 2018), edited by Lino Briguglio of the University of Malta. You can also access this publication on The Social Sciences Research Network.
The forecasts in my paper The Barbados Economy: The Road to Prosperity are based on an empirical model of an export-driven economy, where the source of growth is increased productivity and competitiveness in tourism, other traded services and exports. Foreign exchange inflows and incoming investment generate multiplier effects on domestic production and incomes, which in turn increase the demand for imports, paid for out of the foreign exchange earnings and capital inflows.