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A SMALL FOREIGN EXCHANGE MARKET WITH A LONG-TERM PEG
Abstract
This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy, or of the Central Bank of Barbados. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper is a first analysis of daily transactions in the foreign exchange market of Barbados, a small open economy that has had an unchanged peg to the U.S. dollar for over 30 years. As a result of the credibility of the peg, we expect that capital flows will respond to differentials between U.S. and comparable Barbadian interest rates and that this will result in uncovered interest parity, when allowance is made for market frictions and large discrete events. The results are consistent with this hypothesis about the motivation for foreign exchange transactions.
Keywords: Foreign exchange, exchange rate, interest parity