Taming Volatility : Fiscal Policy and Financial Development for Growth in the Eastern Caribbean

The report is structured in four chapters that outline the main sources of volatility in the region and suggest ways to mitigate the impacts of that volatility on growth. Chapter one presents stylized facts associated with the growth performance of the Eastern Caribbean over the last 40 years. It contrasts the growth performance of the OECS with the rest of the Latin America region and shows that the two groups of countries have shown significant heterogeneity over the business cycle. The chapter also highlights some of the factors that might be responsible for the volatility of growth in the OECS, including the region’s exposure to natural disasters, high debt, and adverse developments in the financial sector. Chapter two provides new evidence on output volatility and the cyclicality of fiscal policy in the OECS and discusses why countries are better off avoiding a pro-cyclical fiscal policy stance. Chapter three assesses the level of financial development in the region as well as the relationship between financial development, growth, and volatility. The chapter also explores critical policy options to strengthen financial development in the OECS. Chapter four assesses empirically the combined effects of terms of trade volatility, fiscal policy (pro) cyclicality, and financial development on growth in the OECS and other countries using two complementary modeling approaches. First, through an econometric model using panel data for 175 countries over the period 1980-2010. Second, by using impulse-response analysis based on a structural model of the business cycle in the OECS region