An Alternative Policy Approach to Growth and Stabilisation in Small Open Economies

Abstract

This chapter recommends an alternative to the standard approach to economic stabilisation and growth policy for small open economies. The standard view, reflected in the analyses of the IMF, other international institutions, most think tanks and the media, is that a combination of credible inflation targetting regimes, flexible exchange rates, and fiscal sustainability are the core elements of a policy regime that is appropriate for all countries, regardless of size. Instead, for small open economies we propose the use of fiscal management to maintain and improve the international competitiveness of the economy, to maximise the inflow of private foreign capital motivated by attractive rates of return, and to stabilise inflation expectations by anchoring the exchange rate to an international reserve currency. This chapter explains the alternative policy framework, and compares it with the standard approach.