3. Data analysis

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Executive Summary

Curacao is a small island located 40 miles north of Venezuela. Formerly, it formed part of the Netherlands Antilles which consisted of five islands in the Caribbean Sea. The Netherlands Antilles was an autonomous country within the Kingdom of the Netherlands. Since October 10, 2010, Curaçao has entered a new constitutional status which is an autonomous country within the Kingdom of the Netherlands. During this transition Curaçao had to decide which exchange rate regime it would introduce in its new constitutional status. In 2010 the government of Curacao opted for the Dutch-Caribbean Guilder to become the country’s currency in its new constitutional status. This is similar to the current exchange rate regime, which is a fixed peg to the United States Dollar. Furthermore, Curacao will form a monetary union together with Saint Martin. They will have a shared central bank and a common monetary unit.

Although the decision has already been made, it would be interesting to know which exchange rate regime would be preferred based on an analysis which uses a ‘public choice’ approach.

According to Frey (1986) the ‘public choice’ approach seeks to analyze political processes, and the interaction between the economy and the polity, by using the tools of modern (neoclassical) analysis. In order to conduct this analysis research will be focused on three interest groups: the government, the trade & industry sector and the trade unions of Curacao. During the analysis those interest groups could choose from three different exchange rate regimes, which are dollarization, a pegged currency and independent floating. For this reason the research question was as follows: “Which exchange rate regime do the main interest groups of Curaçao prefer to introduce in the islands’ new constitutional status based on a public choice approach?”

Based on the analysis done the conclusion can be drawn that a pegged currency is the preferred exchange rate regime for Curacao for the majority of the interest groups (which are the political parties and trade unions). The main reason why are the followings: government receives tax income from the currency conversion profits gained; Curacao has had a positive experience with the pegged currency since 1971; and Curacao will prevent a decrease in the purchasing power.

However, the majority of the Trade and Industry sector prefers dollarization instead of a pegged currency. The main reason why are the followings: dollarization will reduce Curacaos’ cost due to the elimination of transaction costs; dollarization would eliminate the possibility to devaluate the currency; and Curacao will have to earn money before they can spend it, this will create more fiscal discipline for the government and dollarization would decrease the back-office by making the system more lean and mean.

Although the trade and industry sector prefers dollarization, the majority of the interest groups prefer a pegged currency. Thus the preferred exchange rate regime for Curacao based on a public choice approach is the pegged currency.

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1. Introduction

1.1 Introduction

In the past hundred years the choice of exchange rate regime has evolved substantially. Bordo (2007) claims that before 1914, advanced countries adhered to gold while periphery countries either emulated the advanced countries or floated. However, between 1914 and 1972 most of the advanced countries decided not to adhere anymore to the gold standard, although there was a gold standard for some countries after World War II. The Bretton-Wood system was a kind of gold standard which was used after the war. According to Obstfeld and Taylor (2002; as cited in Oesterreichische Nationalbank, 2004) the gold standard with free capital mobility had to be jettisoned in the advanced countries in the face of growing demands by an expanding electorate and organized labor to stabilize the business cycle. In the 1930s capital controls were introduced and in the Bretton Woods era after World War II the adjustable peg. In the late 1960s, the latter was blown apart, leading to the current floating regime (Oesterreichische Nationalbank, 2004).

Since 1976, floating became the dominant exchange rate regime for the major countries in the world economy.

According to several experts, the world is currently marching towards a floating exchange rate regime, although the European countries in the EMU are a notable exception (Oesterreichische Nationalbank, 2004; Reinhart, 2000; Collins, 1996). While the world may be moving in that direction, there is still no perfect exchange rate regime. This is supported by Wyplosz (1999) who argues that the choice of an exchange regime is always a matter of trade-offs, there is never a “better” regime. Additionally, the Oesterreichische Nationalbank (2004) states that no single currency regime is best for all times. Furthermore, to choose an exchange rate regime exhibits a large degree of heterogeneity, even within the same official category (Kimakova, 2008).

Although choosing an exchange rate regime for a country can be considerably complicated, every country has to make a choice. This is also the case in Curacao, which is a small island situated in the southern part of the Caribbean Sea. According to the The Island Territory of Curacao (2008b) Curacao is in a transition process. It is obtaining an autonomous status within the Kingdom of the Netherlands. During this transition Curacao had to decide which exchange rate regime it would introduce in its new constitutional status.

For this reason a conference was held at the Central Bank of the Netherlands Antilles on the August 24^th 2009 which was named “Opportunities and risks of dollarization in the Dutch Caribbean”. The aim was to discuss dollarization and to acquire some insight concerning the potential aftermath after adopting this currency. Dr. Tromp was at this conference, he is the President of the Central Bank of the Netherlands Antilles; he favored the motion to dollarize Curacao and Saint Martin (Extra, 2009). However, the Curacao Bankers Association was against

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dollarization for Curacao due to the fact that the banks would have to sacrifice their second largest source of income if Curacao dollarizes (Extra, 2009). This means that the banks will not generate any income when charging the customers exchange rates when exchanging the domestic currency for the US Dollar and vice versa. In addition, the President of the Central Bank of Aruba recommended continuing using the guilder since it is working well in Aruba, which is already autonomous (La Prensa, 2009). Yet, the President of the bankers association of Saint Martin claims that dollarization is a very complex issue. Hence, he is of the opinion that this topic needs further discussion. (Extra, 2009).

In 2010 the government of Curacao opted for the Dutch-Caribbean Guilder to remain the country’s currency in its new constitutional status. This is similar to the current exchange rate regime, which is a fixed peg to the US dollar. Furthermore, Curacao will form a monetary union together with Saint Martin. They will have a shared central bank and a common monetary unit.

Although the decision has already been made, it would be interesting to know which exchange rate regime would be preferred based on an analysis which uses a ‘public choice’ approach.

According to Frey (1986) the ‘public choice’ approach seeks to analyze political processes, and the interaction between the economy and the polity, by using the tools of modern (neoclassical) analysis. In order to conduct this analysis research will be focused on three interest groups: the government, the trade & industry sector and the trade unions of Curacao. During this analysis the interest groups will be presented the opportunity to choose from a limited number of exchange rate regimes and to identify the regime which they prefer for Curacao. Based on their perspectives, a conclusion will be drawn after the chosen exchange rate regime has proven to be the equivalent to the preferences of the main interest groups.

1.2 Research Question and Sub Research Questions

The main research question is: “Which exchange rate regime do the main interest groups of Curaçao prefer to introduce in the islands’ new constitutional status based on a public choice approach?”

To be able to answer the main research question five sub research questions have been formulated. The first sub research question is “What is an exchange rate regime?” This question will define exchange rate regimes and elaborate on the types of exchange rate regimes that exist. Afterwards an assessment is needed to evaluate which factors should be analyzed when choosing a monetary unit for a country. Consequently the second sub research question is:

“Which factors should be considered when choosing an exchange rate regime?” The answer to this sub research question has to be applied to the Curacaoan context, therefore, the third sub research question is: “How do those factors influence Curacao’s choice for a new exchange rate regime?” Since the ‘public choice’ approach has been chosen as the research method, it is important to know how this can be applied to this research. Consequently, the fourth sub research question is: “How can the public choice approach be applied in researching

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Curacao’s choice for a new exchange rate regime?” When analyzing a research problem with the public choice approach method, data will be gathered from the main interest groups. That is why the last sub research question is: “What are the recommendations from the three main interest groups concerning the choice of an exchange rate regime?” Based on the recommendations from the three main interest groups and also the main factors taken into consideration when choosing a new exchange rate regime, I will present a forecast of the most likely outcome concerning the choice for the new exchange rate regime for Curacao.

Thus the sub research questions are:

 What is an exchange rate regime?

 Which factors should be considered when choosing an exchange rate regime?

 How do those factors influence Curacao’s choice for a new exchange rate regime?

 How can the public choice approach be applied in researching Curacao’s choice for a new exchange rate regime?

 What are the recommendations from the three main interest groups concerning the choice of a new exchange rate regime?

1.3 Methodology

In this section an explanation will be provided on how each sub research question will be answered. In the last part an overview will be provided concerning on how interviews will be conducted.

The first sub research question is: “What is an exchange rate regime?” A definition for exchange rate regime will be given based on a secondary data analysis. Electronic databases, online articles and information available in the University Library will be consulted to collect the necessary information. It should be taken into consideration that when this question will be answered a classification of the different exchange rate regimes will also be provided.

The second sub research question is: “Which factors should be considered when choosing an exchange rate regime?” This will also be answered based on a secondary data analysis. Articles will be collected in which different researchers elaborate on factors which are of influence to the choice of exchange rate regime. Only the most relevant factors will be classified in three groups where they will be discussed exhaustively. In order to do this electronic database, online articles and information available in the University Library will be used to collect the necessary information.

The third sub research question is: “How do those factors influence Curacao’s choice for a new exchange rate regime?” This will be answered based on a secondary data analysis as well.

Information will be gathered concerning the factors previously taken into account, discussed when answering the above mentioned sub research question. These factors will be applied to

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Curacao in order to establish whether or not these factors have any influence on Curacao’s choice for a new exchange rate regime. In order to do this, electronic database, online articles and other information resources available in the University Library will be consulted to collect the necessary information. Nevertheless, the main information will come from the previous sub research question and from an overview of Curacao’s current status.

The fourth sub research question is: “How can the public choice approach be applied in researching Curacao’s choice for a new exchange rate regime?” This will be answered based on a secondary data analysis. First of all, the public choice approach will be defined. Afterwards, a link will be made between the public choice approach and its application to Curacao’s choice for a new exchange rate regime. In order to do this, electronic database, online articles and information available in the University Library will be used to collect the necessary information.

However, the main information will come from the previous sub research question and for an overview of Curacao’s current status.

The last sub research question is: “What are the recommendations of the three main interest groups concerning the choice of a new exchange rate regime?” This will be answered based on primary data collection. Interviews will be conducted with representatives of the following three interest groups: the government, the trade & industry sector and the trade unions of Curacao.

During the interview they will express their preference concerning their choice for the new exchange rate regime. Their motivation in regard to their choice will be evaluated. To get information from the government, interviews will be conducted with politicians, both from the coalition and the opposition, from each political party that was in the government of Curacao, before the election in August 2010. In order to get information from the trade & industry sector interviews will be conducted with companies which operate in the five target sectors of Curacao, namely, Tourism, Logistics, E-commerce, International Financial Services and Oil Processing (The Island Territory of Curacao, 2008). Lastly, the leaders of trade unions at national level will be interviewed, in order to get the information from the trade unions of Curacao.

One important issue that should be taken into consideration during the interviews is answering this sub research question. The factors encountered, while answering the third sub research question, will be evaluated in order to explain the preference of the different interest groups.

Furthermore, some factors could be added based on the interviews and/or questionnaires which will be conducted with people from the different interest groups. The factors encountered while answering this sub research question will be used to assess within the three different perspectives why they prefer a particular exchange rate regime.

1.3.1 The interviews

The sampling frame for the first interest group, which is the government, consists of politicians who are in the opposition and coalition of the government of Curacao before the election in August 2010. From every political party one person will be interviewed to determine which

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exchange rate regime their political party prefers and why. A semi-structured questionnaire will be used when collecting data. Furthermore, convenience sampling and snowball sampling will be used due to the considerable difficulty encountered when collecting the necessary information, from randomly selected participants in this research.

The sampling frame for the second interest group, which is the industry and trade sector, consists of all the companies in Curacao which operate in the five target sectors of Curacao. A number of companies will be interviewed, within every sector, by using a structured questionnaire. The companies where chosen from a list provided in Open Arms 2008, which is a research paper written by the Department of Economic Affairs of the Island Territory of Curaçao. In this paper they elaborate on the five target sectors of Curaçao and provide the names of the major companies in the different sectors. For this research the companies (or representatives of different sectors) were chosen based on convenience sampling from the list provided.

The sampling frame for the third sub interest group, which is the trade union, consists of representatives of the trade unions at national level. One representative from every trade union will be interviewed.

1.3.2 Dealing with reliability and validity when conducting interviews

To ensure the reliability of this research, interview reports will be made immediately after the interview has been conducted. These reports will be verified for accuracy by the people who were interviewed, corrections will be made if deemed necessary. One other aspect that will be taken into consideration to ensure the reliability is to interview the right person. To ensure this, the political parties will assign one person, who in their opinion, is the most suitable. Also in the trade & industry sector, the company will have to assign one person who they think is the most suitable for this research. This is also the case when gathering information from the trade unions.

Additionally, many open-ended response questions will be used during the interviews, to make sure that the response elicited by these questions is valid. Based on the answer of the interviewee the interviewer will ask more questions to clarify the answer in that manner an answer can be obtained which is coherent with information he wants to get from the interviewee. In addition, the interviews will be conducted at the most convenient place for the interviewee. Also the interviewees will receive the interview questions in advance in order for them to prepare beforehand and to be able to answer the questions without any problem. If they do not understand the questions, they can ask the interviewer in to clarify the questions prior to the interview.

1.3.3 Data analysis

The data collected from the questionnaires will be inserted in SPSS to be analyzed through descriptive and inferential statistics. Based on those findings conclusions can be drawn.

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However, the interviews and the qualitative data from the questionnaires will be analyzed by using the jigsaw puzzle analogy created by Seidel (1998). This model is presented in figure 1.

According to Seidel (1998) the qualitative data analysis process consists of three parts, which are noticing, collecting and thinking about interesting things. During the first part, noticing, I will be producing a record of

the things that I have noticed. Furthermore I will also code them. In the second part, collecting, I will sort the pieces I noticed previously. In the last part, thinking, I will examine the thing I have collected. My goal will be to make an attempt at making sense out of each collection, by looking for patterns and relationships both within collection, and also across collection, and also to make general discoveries about the phenomena I am researching. However, the process of qualitative data analysis is iterative and progressive because it is a cycle that keeps repeating. The process is also recursive because one part can call you back to a previous part. Additionally it is holographic because in each step the process contains the entire process.

1.4 Structure of Thesis

In this chapter a background has been given concerning the research topic. Also the research questions and the methodology were discussed. In chapter 2 the theoretical framework will be provided and explained extensively. Chapter 3 provides the data analysis of the interviews done.

The last chapter provides an answer for the research question and recommendations for further research.

Notice Things

Think About Things

Collect Things Figure 1. Jigsaw puzzle analogy by Seidel (1998)

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Figure 2. Conceptual model Defining Exchange

Rate Regime (ERR)

Factors influencing ERR choice

Overview of Curaçao

Assessment of factors for Curaçao Defining Public

Choice Approach

Assessment of Interest Groups on ERR

Recommended ERR for Curaçao

2. Theoretical Framework

2.1 Conceptual Model

The conceptual model for this research is illustrated here, in figure 2. This conceptual model will be elaborated on in detail in the following sections.

2.2 Exchange Rate Regime The main concept for this research is exchange rate regime.

According to Flynn (2008) exchange rate regimes, also called currency institutional regimes, refer to specific institutional structures designed to produce specific exchange rate outcomes.

2.2.1 Classifications of exchange rate regimes

There are several classifications of exchange rate regimes. Eiteman, Stonehill & Moffertt (2007) elaborate on two types of exchange rate regimes. They claim that if the government of a country – for example, Argentina – regulates the rate at which the peso is exchanged for other currencies, the system or regime is classified as a fixed exchange rate regime. And, if the government does not interfere in the valuation of this currency in any way, the currency is classified as floating or flexible. However, Flynn’s classification is slightly different. Flynn (2008) claims that the main exchange rate regimes, including floating, fixed, and pegged, are characterized by different levels of control and produce different results. In her study Flynn (2008) used Tavlas classification which is as follows:

 Pegged exchange rate regimes include a set exchange rate targets. Policymakers use monetary policy to maintain the established exchange rate target.

 Managed exchange rate regimes have no constant exchange rate target. Instead, policymakers tweak interest rates to raise or lower the exchange rate as needed.

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 Floating exchange rate regimes have no commitment to a specific exchange-rate target.

In floating exchange rate regimes, the exchange rate is determined by market supply and demand rather than macroeconomic policy.

An extended classification is provided by the International Monetary Fund (IMF), which actually has classified every exchange rate regime of every country in their framework. According to the IMF (2004) exchange rate regimes can be classified as follows:

Exchange Arrangements with No Separate Legal Tender

The currency of another country circulates as the sole legal tender (formal dollarization), or the member belongs to a monetary or currency union in which the same legal tender is shared by the members of the union. Adopting such regimes implies the complete surrender of the monetary authorities' independent control over domestic monetary policy.

Currency Board Arrangements

A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation. This implies that domestic currency will be issued only against foreign exchange and that it remains fully backed by foreign assets, eliminating traditional central bank functions, such as monetary control and lender-of-last-resort, and leaving little scope for discretionary monetary policy.

Other Conventional Fixed Peg Arrangements

The country (formally or de facto) pegs its currency at a fixed rate to another currency or a basket of currencies, where the basket is formed from the currencies of major trading or financial partners and weights reflect the geographical distribution of trade, services, or capital flows. The currency composites can also be standardized. There is no commitment to keep the parity irrevocably.

Pegged Exchange Rates within Horizontal Bands

The value of the currency is maintained within certain margins of fluctuation of at least ±1 percent around a fixed central rate or the margin between the maximum and minimum value of the exchange rate exceeds 2 percent. There is a limited degree of monetary policy discretion, depending on the band-width.

Crawling Pegs

The currency is adjusted periodically in small amounts at a fixed rate or in response to changes in selective quantitative indicators, such as past inflation differentials vis-à-vis major trading partners, differentials between the inflation target and expected inflation in major

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trading partners, and so forth. The rate of crawl can be set to generate inflation-adjusted changes in the exchange rate (backward looking), or set at a preannounced fixed rate and/or below the projected inflation differentials (forward looking). Maintaining a crawling peg imposes constraints on monetary policy in a manner similar to a fixed peg system.

Exchange Rates within Crawling Bands

The currency is maintained within certain fluctuation margins of at least ±1 percent around a central rate-or the margin between the maximum and minimum value of the exchange rate exceeds 2 percent-and the central rate or margins are adjusted periodically at a fixed rate or in response to changes in selective quantitative indicators. The degree of exchange rate flexibility is a function of the band width. The commitment to maintain the exchange rate within the band imposes constraints on monetary policy, with the degree of policy independence being a function of the band width.

Managed Floating with No Predetermined Path for the Exchange Rate

The monetary authority attempts to influence the exchange rate without having a specific exchange rate path or target. Indicators for managing the rate are broadly judgmental (e.g., balance of payments position, international reserves, parallel market developments), and adjustments may not be automatic. Intervention may be direct or indirect.

Independent Floating

The exchange rate is market-determined, with any official foreign exchange market intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it.

2.2.2 Advantages and disadvantages of three exchange rate regimes

It is clear, from the previous classifications, that there are several types of exchange rate regimes which differ in the amount of fixity, as Bordo (Oesterreichische Nationalbank, 2004) calls it.

Every level of fixity has its advantages and disadvantages. Since this research will focus only on three different exchange rate regimes only the advantages and disadvantages of these exchange rate regimes will be discussed in this section. But firstly, an explanation will be provided indicating which exchange rate regimes will be analyzed and why.

The first exchange rate regime that will be analyzed is dollarization, which is classified as the Exchange Arrangements with No Separate Legal Tender by the IMF. This exchange rate regime will be analyzed due to the fact that the USD (United States Dollar) is of crucial importance for Curacao. The United States is one of the major trading partners of Curacao (The Island Territory of Curacao, 2008), hence the relevance of the USD. More than 60% of its international relations

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(or transactions) have been conducted with the United States or in US dollars (Central Bank of the Netherlands Antilles, 2010).

The second exchange rate regime that will be analyzed is a pegged currency, which is classified as an Other Conventional Fixed Peg Arrangements by the IMF. The main reason why is because Curacao (while being part of the Netherlands Antilles) has had its currency pegged to the United States Dollar (USD) since 1971. According to The Island Territory of Curacao (2008a) the main goal of the policy conducted by the Central Bank of the Netherlands Antilles (BNA), is to safeguard the stability of the external value of the Netherlands Antilles guilder at the fixed exchange rate of NAG1.79 for 1 USD. Thus, the BNA already has extensive experience with this type of exchange rate regime. More information concerning the current exchange rate regime of the Netherlands Antilles will be given in paragraph 2.4.1

The third and last exchange rate regime that will be analyzed is Independent Floating as classified by the IMF, in view of the assertion presented by Bordo; (Oesterreichische Nationalbank, 2004). He claims that the world is evolving towards a floating exchange rate regime. This is also supported by Collins (1996) who attests that there has been a striking shift from fixed to more flexible exchange rate regimes among countries in Latin America and the Caribbean. For these reasons it would be thought-provoking to know if Curacao is capable of managing a flexible exchange rate. Furthermore, it would be interesting to know what the advantages and disadvantages are when changing from a peg to a flexible exchange rate regime for Curacao.

Now the advantages and disadvantages will be discussed. The advantages of dollarization are the following. Firstly, dollarization reduces transaction cost among countries using the same currency which stimulates economic integration with those countries (Yeyati & Sturzenegger, 2003; De Grauwe, 2007). A good example of this it the European Community Commission which has estimated gains from the elimination of transaction costs at a number between 13 billion and 20 billion Euros per year, which represents between 0.25 and 0.5 percent of GDP per year (De Grauwe, 2007). In addition, the larger the gains are, the stronger the trade links are within the common currency area (Yeyati & Sturzenegger, 2003).

Secondly, dollarization enhances (both monetary and fiscal) policy credibility resulting in lower inflation rates, lower real exchange rate volatility and a deepening of the financial system (Yeyati & Sturzenegger, 2003; De Grauwe, 2007). This is supported by Yeyati & Sturzenegger (2003) who claim that fixed exchange rate regimes advocates traditionally highlighted two important dimensions in which a commitment to a fixed parity can provide a country with important credibility benefits. First of all, the commitment removes the inflation bias à la Barro- Gordon by which a government may be lured to inflate the economy through unforeseen money injections. Secondly, by removing inflationary financing of the deficit, the commitment enacts

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stronger financial limitation on the government, which in turn has no choice but to keep its budget in check.

Thirdly, it reduces sovereign risk by eliminating currency risk and the occurrence of costly speculative attacks (Yeyati & Sturzenegger, 2003). Fourthly, it reduces price uncertainty, which improves the allocative efficiency of the price mechanism (De Grauwe, 2007). De Grauwe (2007) claims that this, in its turn, improves welfare, although it is difficult to quantify this effect. Lastly, it can increase competition somewhat, benefiting consumers (De Grauwe, 2007).

This is due to the fact that the existence of a common currency stimulates integration in political, institutional and financial areas, which will eventually lead to more competition; and more competition means either a lower price for the same product or a higher quality for the same price, both factors will be beneficial for the consumers.

However, a disadvantage of dollarization, according to Yeyati & Sturzenegger (2003), is the loss of the exchange rate instrument to buffer the economy against real or external shocks (loss of monetary independence). This is because a floating regime has the capability to guard the country from external interest rate variations and to use monetary policy as an aggregate demand management tool, under the presumption that domestic interest rates are (more) autonomous in this case.

Secondly, Yeyati & Sturzenegger (2003) claim that the elimination of the local currency entails a fiscal cost arising from the loss of seigniorage revenues. They continue claiming that the degree of monetization is higher in developed than in developing countries, which suggest that for the latter, the rate of growth of the demand for money may be higher in the short run than in the steady state if levels eventually converge to those of more developed economies. This means that there will be additional seigniorage cost in the form of higher flow costs, in the transition period.

Thirdly, Yeyati & Sturzenegger (2003) claim that the use of a foreign currency, for financial intermediation, eliminates the capacity of the domestic central bank, to finance its Lender of Last Resort activities. This means that the local central bank will lose its ability of providing additional liquidity to the banking sector, in the event of a transitory shortage. According to Poirson (2001) dollarization will also create a strong sensitivity to external shocks and real domestic shocks.

The complete opposite of dollarization is Independent Floating. One of the advantages of the Independent floating is that it neutralizes the impact of external shocks (Poirson, 2001;

Stockman, 1999). Due to the fact that the exchange rate is floating, it can be easily readjusted to prevent catastrophic consequences caused by changes in exogenous factors. In addition it neutralizes the impact of real shocks and the effect of inflation on export competitiveness (Poirson, 2001). However, a disadvantage of floating is that there may be a negative effect of strong volatility on trade and financial transactions (Poirson, 2001). This could create an unstable

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trade and financial environment for the companies within these sectors since unexpected changes in the exchange rate, makes it difficult for companies anticipate future transactions. Also current revenues and costs could differ from the amount they planned to in advance, which could have negative consequences for companies operating in the financial and trade sectors. In addition it is the source of imported inflation and can lead to postponement of required structural adjustments (Poirson, 2001).

The advantages of a pegged currency (Other Conventional Fixed Peg Arrangements as classified by the IMF) are the followings. Firstly, pegging the exchange rate may provide a commitment to monetary policy (Stockman, 1999). Countries which peg their currency are responsible to maintain their commitment by making use of their monetary instruments. This should lead to a commitment of their monetary policy. Secondly, the unpredictable volatility of a floating exchange rate, both from a short- term perspective and a long-term one, can inflict damage (Obstfled & Rogoff, 1995). In other words, pegging reduces the volatility of the exchange rate.

This is beneficial for companies especially in the trade and financial sector, as explained previously. A third advantage is that pegging to a low- inflation currency will help to restrain domestic inflation pressures, whether these originate in excessive government budget deficits or in the wage- and price-setting decisions of the private sector (Obstfled & Rogoff, 1995).

Basically, an announced policy of pegging the exchange rate may serve as a commitment technology permitting the government to fight and even predict succeeding temptations to follow extremely expansionary macroeconomic policies. Fourthly, Bruno (as cited in Obstfled &

Rogoff, 1995) claims that fixed rates have the attraction of anchoring price inflation for internationally traded goods and providing a guide for private-sector inflation expectations.

Conversely, a disadvantage of a pegged currency is that a government that fixes its currency's exchange rate loses control of the domestic money supply (Obstfled & Rogoff, 1995). Secondly, when a currency is pegged your country depends on the monetary policy of the anchor country (Poirson, 2001). Furthermore, Poirson (2001) claims that if credibility is fragile, consequently in case of crisis, adjustment may be too costly.

2.3 Factors influencing exchange rate regime choice

Now that it is clear which exchange rate regimes and monetary units there are, an assessment should be conducted in regard to the different factors that influence the type of exchange rate regime countries choose, when introducing their new exchange rate regime. These factors consequently influence the choice of monetary unit for it is linked to the exchange rate regime.

Those factors have been studied extensively by several researchers. For the sake of clarity, these factors have been grouped within three categories which will be discussed in the following paragraphs.

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17 2.3.1 Economic factors

One economic factor which has an influence on choosing an exchange rate regime is the size (or GDP) of a country (Collins, 1996; Poirson, 2001; Carmignani, Colombo & Tirelli, 2008).

Poirson (2001) claims that larger economies tend to select more flexible exchange rates. The rationale behind this is that small countries will find it more difficult than larger countries to manage a flexible exchange rate regime, which is why a small country would opt to fix its exchange rate regime while a larger country would let it be flexible. According to Collins (1996) countries with moderate to high inflation rates are less likely to select fixed exchange rates. This is due to the fact that such countries should anticipate more rapidly growing misalignment of their real exchange rates under fixed rate regimes unless the fixed rate is adjusted frequently (Collins, 1996). For this reason the second factor is the inflation rate, which is also supported by Poirson (2001) and Carmignani, Colombo & Tirelli (2008). In addition, Savvides’ (1990) investigation into the determinants of the choice of exchange rate regime suggests that countries experiencing greater real exchange rate variability opt for more flexible exchange rate arrangements. The rationale behind this is that over the longer term, a flexible exchange rate policy may be more successful in stabilizing the real exchange rate. For this reason the third factor to consider when choosing an exchange rate regime is the variability of the real exchange rate. The fourth factor is the openness of the economy (Collins, 1996; Carmignani, Colombo &

Tirelli, 2008). According to Carmignani, Colombo & Tirelli (2008) a country is less likely to adopt a fixed exchange rate if it is relatively large and closed. This is also supported by Barth &

Wong (1994) who claim that one of the crucial issues that revolve around the choice of an exchange rate regime is the relationship of national economies to the global system. The trade structure of a country has implications for the exchange rate regime as well. In a study concerning economic policy for external balance Branson (1983) presents the characteristics of different types of trade structure, in terms of specific values for elasticities of demand or supply in the export and import. Based on his study, it can be concluded that trade structure of economies should also be evaluated, when choosing an exchange rate regime.

2.3.2 Monetary factors

One monetary factor which should be considered when choosing an exchange rate regime is the constraint that an exchange rate regime imposes on monetary policy (Wyplosz, 1999). Wyplosz (1999) argues that especially when there is a large degree of capital mobility, an exchange rate commitment, whether explicit or implicit, leads to market-based discipline imposed on the central bank. Another monetary factor that is of importance is the duration of the exchange rate regime (Andreou, 2009). According to Andreou (2009) a longer-lived arrangements tend to be associated with peaceful exits. This indicates that there will be less resistance to change an exchange rate regime when it has existed for a long period compared to an exchange rate regime which was introduced a couple of years ago. Furthermore, Poirson (2001) states that the exchange rate risk exposure increases the likelihood of fixing the exchange rate. The main reasoning behind this is that a lower ability to hedge the exchange rate risk tends to decrease

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flexibility of the exchange rate regime. Therefore a third monetary factor is the exchange rate risk exposure. Last, the level of reserves is an important monetary factor as well. Poirson (2001) proves in his research that lower reserves have a positive and significant effect on exchange rate regime flexibility.

2.3.3 Political factors

Political economy theories show that a country lacking political stability has an incentive ceteris paribus to let its exchange rate float as it lack the political ability and political support for the unpopular measures that may be required to defend a peg (Poirson, 2001). For this reason, political stability is one political factor that should be considered when choosing an exchange rate regime. Another political factor is the electoral cycle. This is supported by Aisen (2004, as cited in Carmignani, Colombo & Tirelli, 2008) who finds that, on average, exchange rate based stabilizations are launched before elections while money based stabilizations are implemented after them. This clearly indicates that the electoral cycle of the current government may influence the choice of the exchange rate regime. In addition, the political business cycle literature argues that politicians in the governing parties manipulate macroeconomic policy before the election takes place in order to produce an economic boom to win the next election (Hossain, 2009). Bernhard and Leblang (1999 as cited in Hossain, 2009) argue that the electoral system and legislative institutions have an influence on the choice of exchange rate regime. That is why the electoral system is also a relevant factor which should be considered. Moreover, Edwards (1996, as cited in Poirson, 2001) argues that a government with an “ambitious”

unemployment objective has a high temptation to inflate, and thus ceteris paribus, a high incentive to “tie its own hands” by pegging the exchange rate. Thus the temptation to inflate is a crucial political factor as well.

2.4 Overview of Curacao

Curacao is a small island located 40 miles north of Venezuela. It is Dutch overseas territory with 141,766 inhabitants in 2009 (CBS, 2009). Together with Bonaire, Saint Martin, Saba and Saint Eustatius (which are also islands in the Caribbean Sea and former Dutch colonies) they formed the Netherlands Antilles until October 10, 2010. The Netherlands, Aruba and the Netherlands Antilles together formed the Kingdom of the Netherlands. According to the Island Territory of Curacao (2008a) the Netherlands Antilles achieved full autonomy with respect to its internal affairs in 1954. Aruba, which was formerly also one of the islands of the Netherlands Antilles, assumed a separate status within the Kingdom of the Netherlands in 1986. The Netherlands Antilles had two levels of government: a central (federal) government and a territorial (island) government (Island Territory of Curacao, 2008b). However, since October 10, 2010, Curaçao has only one level of government and has achieved full autonomy.

Curacao is a melting pot of different ethnic groups consisting of predominantly mixed Afro- Caribbean together with European descent, Dutch, Latin American, South Asian, East Asian,

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Portuguese, Caribbean and more than 40 other countries. The majority of the residents, known as the “Yu di Kòrsou” (which means child of Curacao) speaks four languages, the official languages are Dutch and Papiamentu, and they also speak Spanish and English. The citizens of Curacao are relatively well educated, 99% of the residents have at least the primary school education leaving only a minor 1% having no form of education at all.

Curacao’s major trading partners are Europe, US and Venezuela (The Island Territory of Curacao, 2008b). The main pillars of Curacao’s economy are tourism, logistics (transport sector), e-commerce, international financial services, and oil processing. The economy of Curacao is small, yet diversified.

According to The Island Territory of Curacao (2008b) Curacao is presently in a transition process of obtaining an autonomous status within the Kingdom of the Netherlands. According to the Government of Curacao (2009) this means that Curacao will no longer be a part of the Netherlands Antilles but it will become a country within the Kingdom of the Netherlands.

Furthermore, there will only be one level of government instead of two. Moreover, there will be only one election and all the money that is produced in Curacao will be invested in Curacao, none of it will go to the other islands, which currently form part of the Netherlands Antilles.

According to the current plans of the government, Curacao will enter its new constitutional status on the 10^th of October 2010, which has been the case on that date. After the conference which was held at the Central Bank of the Netherlands Antilles on the August 24^th 2009 named

“Opportunities and risks of dollarization in the Dutch Caribbean”, no one published any information concerning the choices of exchange rate regime which are presently being considered. Only the advantages and disadvantages of dollarization are discussed. Yet, only one thing is certain in relation to the new exchange rate regime (and monetary unit), Curacao and Saint Maarten will share one central bank, containing one set of rules, one supervisor for the regular monetary and financial supervision (behavioral and prudential); and for the integrity supervision (Final Declaration, 2006).

2.4.1 Current monetary policy of Curacao

The monetary unit of Curacao is the Netherlands Antillean guilder, the international symbol is ANG. According to the Island Territory of Curacao (2008b) the guilder (ANG) has been pegged to the US dollar at the following exchange rate:

 Buying rate banknotes: ANG. 1.77;

 Buying rate draft, cheques, traveler’s cheques & transfers: ANG. 1.78;

 Selling rate to the public: ANG 1.82.

The guilder (ANG) has been pegged to the US dollar since December 23, 1971, by law. It has never been changed. The main reason why it is pegged to the US dollar is because most

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Table 1. GDP & inflation in Curaçao (Source: CBS, 2009)

2005 2006 2007 2008

Gross Domestic Product, market prices (mln ANG) 4198.9 4389.6 4665.5 5080.4

Nominal GDP growth (%) 4.9 4.5 6.3 8.9

Inflation (%) 4.1 3.1 3 6.9

Real GDP growth (%) 0.8 1.5 3.5 2.2

international transactions of the Netherlands Antilles (which also included Curacao) are denominated in US dollars. This is supported by the Central Bank of the Netherlands Antilles (2010a) who claims that the main reason for pegging the ANG to the US dollar is that over the years, more than 60% of its international trade relations have been conducted with the United States or in US dollars. The Central Bank of the Netherlands Antilles (BNA) is currently responsible for the monetary policy. The main goal of the policy conducted by the BNA, is to safeguard the stability of the external value of the Netherlands Antilles guilder at a fixed exchange rate at NAG1.79 for 1 USD (Island Territory of Curacao, 2008b). In order to preserve confidence in the exchange rate the BNA objects at maintaining a level of official reserves (excluding gold) which is worth three months of merchandise imports. The instruments used in the implementation of the monetary policy are the monetary cash reserve arrangement, the reserve requirement, the policy on foreign positions and the use of money market instruments.

Monetary policy instruments in use by the BNA are mainly aimed at influencing the liquidity position of the commercial banks (Central Bank of the Netherlands Antilles, 2010b). The money market instruments the BNA has at its disposal are the Certificates of Deposit, Repurchase Agreements and outright sale of government securities.

Although the Central Bank has been able to maintain the peg since 1971, there has been a force increase in the balance of payment risks. This is due to a force increase in the Current Account deficit between 2004 and 2008. In 2004, the Current Account deficit was NAF 158 million, but it became NAF1,561 million in 2008, which means that it has increased 10 times over in 5 years.

This is surely one of the aspects that must be taken into consideration when evaluating the preference of the interest groups because the different exchange rate regimes will have different consequences for the Current Account deficit.

2.5 Assessment of ERR-choice factors for Curacao

In this section every factor which influences the choice for an exchange rate regime will be assessed. They will be applied to Curacao’s current state in relation to those factors.

2.5.1 Economic factors

Curacao’s GDP (Gross Domestic Product) is illustrated in Table 1, for the years 2005 to 2008.

From this table can be concluded that the nominal and real GDP has been growing for the last couple of years, although a high inflation rate decreased the real GDP growth considerably in 2008. As stated previously, larger economies tend to select more flexible exchange rates (Poirson, 2001). This means that Curacao will opt for a fixed exchange rate regime based on the fact that its GDP is significantly

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Figure 3. Exchange Rate for Curaçao (Source: CBS, 2009 and Rate Inflation, 2010)

low (compared to other countries such as Holland) and the increase in the Real GDP is not that large. Due to the fact that the country’s GDP is small, it would be difficult for Curacao to manage a flexible exchange rate regime.

Focusing solely on the inflation rate, CBS (2010) concludes that, in the last eleven years, Curacao has been experiencing a strong fluctuating inflation; which varied between 0.4 and 6.9 percent, that resulted in an average of 2.75 percent. It should also be noted that in 2009, the inflation rate was 1.8%, which is a quarter of the inflation rate in 2008. This means that the inflation rate decreased substantially compared to 2008. However, Collins (1996) claims that countries with moderate to high inflation rates are less likely to select fixed exchange rates. Thus based on the average inflation rate and the inflation rate of 2009, Curacao would opt for a flexible exchange rate regime.

The variability of the real exchange rate of Curacao is illustrated in figure 3. The real exchange rate has been calculated by using the following formula:

In this formula e is equal to the nominal exchange rate, which equal NAG 1.82 in exchange for $1. The Consumer Price Index of the USA is p* and the Consumer Price Index of Curacao is p. The base year for the indexes is 1971 due to the fact that the current exchange rate regime was established in 1971. The main reasons why only the US dollar was taken into consideration is because the local currency is currently pegged to the US dollar and more than 60% of its international trade relations have been conducted with the United States or in US dollars (Central Bank of the Netherlands Antilles, 2010a).

Based on figure 3 the following conclusions can be made. Between 1971 and 1983 the real exchange rate appreciated from 100 to 84.2, which implies that Curacao’s competitive advantage worsened during this period. Between 1984 and 2004 the real exchange rate depreciated from 84.2 to 98.3. Consequently, Curacao’s competitive position strengthened compared to the United States during those years. However, since 2005 the real exchange rate has been appreciating again, implying that Curacao’s competitive advantage has been worsening again. This is

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Table 2. Openness of Curaçao’s economy (Source: CBS, 2009)

2006 2007 2008

Gross Domestic Product, market prices (mln ANG) 4389.6 4665.5 5080.4

Export (mln ANG) 411.45 368.55 477.75

Import (mln ANG) 2912.1 3243.6 4076.6

Openess = (Export+Import)/GDP 0.76 0.77 0.90

beneficial for the import of Curacao but unfavorable for the export. Due to the appreciation of the real exchange rate the goods which are being imported become cheaper whereas the price of the goods that are exported increase. This will eventually benefit the economy since the import of Curacao is larger than the export. Consequently, the trade deficit should also decrease to some extent. Now, evaluating the variability of the real exchange rate regime in figure 3, it is undoubtedly evident that the real exchange rate fluctuated considerably since 1971. There is not , however, a clear pattern for the movement of the real exchange rate either. Based on Savvides’

(1990) investigation into the determinants of the choice of exchange rate regime, can be concluded that Curacao, which is experiencing high real exchange rate variability, will opt for more flexible exchange rate arrangements. The rationale behind this is that over the longer term, a flexible exchange rate policy may be more successful in stabilizing the real exchange rate.

In table 2 the openness of Curacao’s economy is calculated by adding the export to the import and divided the sum with the total GDP for that year. It should be noted that the export and import are estimated due to the fact that the oil import and export are not included in the original data. They were added by calculating the proportion of oil out of the total import and export, which were 70% and 95% respectively. These were added to come up with the figures in the tables. One aspect is for certain, Curacao’s economy is very open due to the fact that the export together with the import form a large percentage of Curacao’s GDP. According to the World Bank (2010) the openness of Latin America & the Caribbean is 0.46, 0.47 and 0.47 for respectively 2005, 2007 and 2008. When comparing this to Curacao, the conclusion can be made that the economy of Curacao is more open than most of the countries and islands in its region.

Furthermore, the openness has been increasing in the last three years. Rodriguez (2000) claims that the smaller the country the more open it should be, which is exactly the case for Curacao being a small island with an open economy.

Based on the different types of trade structure, Branson (1983) characterizes, in his article, that Curacao’s trade structure can be classified as a small country. The main characteristic of a small country is that it cannot influence the world prices of its import and export. This is exactly the case for Curacao due to the fact that its export and import level are exorbitantly low to influence world prices. Furthermore, oil sums up to 49% of its exports and 41% of its imports. Since Curacao is a really small country compared to other countries such as the United States and Holland, it cannot influence oil prices, although it is a large proportion of its export and imports.

This means that the demand for import and export, of the main import and export product of Curacao (which is oil) is inelastic. Consequently, Curacao would be better off with a fixed

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exchange rate regime in order to have a more stable exchange rate which could lead to a decrease in the trade deficit.

Concerning the classification of a small country, Branson (1983) concludes that in a small country, the exchange rate changes stabilize the trade balance with no effect on the terms of trade. In addition, he claims that this is consistent with a policy that uses the exchange rate for external stabilization purposes. This implies that Curacao should choose an exchange rate regime which will be able to stabilize the trade balance for more than 60% of Curacao’s international trade relations have been conducted with the United States or in US dollars. It would be better for Curacao to peg its currency to the US dollar. A pegged exchange rate prevents unnecessary trade deficits caused by fluctuating exchange rates. Over the past couple of years Curacao has already had a trade deficit. Thus based on the trade structure of Curacao, taking the inelastic supply of export products and the inelastic demand of import products into consideration, a fixed exchange rate regime would be more beneficial for the economy.

Based on the evaluation of the economic factors the following conclusion can be made. The size of Curacao’s GDP is growing but its GDP is still considerably small compared to that of larger economies, for instance the United States. For this reason it will more inclined to maintain a fixed exchange rate regime. Based on the inflation rate, which has been low in the last five years (expect in 2008), can be concluded that Curacao will choose for a flexible exchange rate regime.

The analysis of the real exchange rate variability shows that a flexible exchange rate policy may be more successful in stabilizing the real exchange rate, which has been fluctuating a great deal since 1971. In addition, Curacao has an open economy, especially when it is compared to other countries in Latin America and in the Caribbean. This on its turn indicates that they would probably opt for a fixed exchange rate regime. Last, based on the trade structure of the economy, Curacao should opt for a fixed exchange rate, with the result that it will prevent a larger trade deficit caused by exchange rate fluctuations. Thus, every economic factor, except inflation rate and the real exchange rate, indicates that Curacao will rather prefer a fixed exchange rate regime to a flexible one.

2.5.2 Monetary factors

One crucial monetary factor is the constraint an exchange rate regime puts on monetary policy.

Due to the fact that ANG is pegged to the US dollar, the BNA has lost some control of the domestic money supply (Obstfled & Rogoff, 1995) and Curacao depends, to some extent, on the monetary policy of the peg country (Poirson, 2001) which is the United States. So the monetary policy of Curacao has its limitation, however the BNA uses its monetary instruments to minimize the hindrance. Until now, the BNA has been to able to deal with this constraint, thus maintaining the current exchange rate regime will not have a negative or unexpected impact on the BNA’s monetary policy.

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Evaluating the duration of the current exchange rate regime, it can be concluded that the current exchange rate regime is almost 39 years old since it was introduced in 1971. According to Andreou (2009) constant arrangements tend to be associated with peaceful exits. In other words, due to the fact that the current exchange rate regime excited for so many years it is easier to change it to another regime. However, the majority of the interest groups did not want to dollarize Curacao after the conference, which was held at the BNA on the August 24^th 2009 named, “Opportunities and risks of dollarization in the Dutch Caribbean”. Dollarization was one of the main topics to be discussed at this conference. Nevertheless, nothing else was published concerning this issue, after this conference. It is therefore not clear if changing the current exchange rate regime, which has been established for almost 39 years, will be a simple task.

The third monetary factor is the exchange rate risk exposure. Due to the fact that this is difficult to measure on country-level for it is used on business-level, the exchange rate risk exposure will only be evaluated at the companies that will be represented in this research. Although it is important to know that there are different types of exchange rate risk exposure, Eiteman, Stonehill and Moffett (2007) classify them into three different types, which are transaction, operating, and translation exposure. These types have been described as follows:

 Transaction exposure measures changes in the value of outstanding financial obligations, incurred prior to a change in exchange rate but not due to be settled until after the exchange rates changes.

 Operating exposure measures: the change in the present value of the firm, resulting from any change in future operating cash flows of the firm, caused by unexpected change in exchange rates.

 Translation exposure is the potential for accounting-derived changes in owner’s equity to occur due to the need to “translate” foreign currency financial statements of foreign subsidiaries into a single reporting currency, to prepare worldwide consolidated financial statements.

In this research, the focus will only be on operating exposure. More on this issue will be discussed in the analysis of the interviews and it will be also briefly discussed in paragraph 2.7.

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Table 3. International reserves position (Source: BNA, 2010)

2002 2003 2004 2005 2006 2007 2008 International reserves 1173.5 1360.8 1461.6 1627.9 1772.4 2121.6 2600.6 Central Bank 853 904.5 1015.3 1117.9 1251.9 1620.6 2010.7

Gold 138.9 237 271.7 305.5 365.8 437.6 544.9

Official forex reserves 714.1 667.5 743.6 812.4 886.1 1183 1465.8 Commercial banks 320.5 456.3 446.3 510 520.5 501 589.9

Import coverage (months) 3 3.2 2.7 3 2.7 2.7 3

Table 3 provides an overview of the level of reserves of the BNA. As stated in paragraph 2.4.1, in order to preserve confidence in the exchange rate the BNA objects at maintaining a level of official reserve (excluding gold) which is worth three months of merchandise imports. The instruments used in the implementation of the monetary policy are the monetary cash reserve arrangement, the reserve requirement, the policy on foreign positions and the use of money market instruments. Based on this table 3 can conclude that in most years the BNA has had more or less enough reserves to cover three months of its import, however in 2004, 2006 and 2007 there was a sudden lack. Poirson (2001) proves in his research that lower reserves have a positive and significant effect on exchange rate regime flexibility. Due to the fact that in the recent years there was a lack Curacao may consider becoming more flexible with its exchange rate regime. In 2008, the level of reserves was enough, again.

Based on the evaluation of the monetary factors the following conclusion can be drawn. Due to the fact that Curacao is currently pegged, it has a constraint on its monetary policy. However, by making use of monetary instruments it has been able to minimize the constraint. This means that maintaining its current exchange rate regime should really be considered due to the well- functioning of the current exchange rate regime, which is to some extend fixed (pegged). Based on the duration of the current exchange rate regime, theoretically speaking, a peaceful exit could be guaranteed. An evaluation of the exchange rate risk exposure will be provided in paragraph 2.7. Last, in view of a lack in reserves, in the recent past, more flexibility should be considered, although in 2008 the level of reserves was high enough.

2.5.3 Political factors

It is important to know that Curacao has two levels of government, of which the first has already been discussed in paragraph 2.4. The second level is the kingdom government, which consisted of the Netherlands, Curaçao, Saint Martin, Aruba and the BES-islands (Bonaire, Statia and Saba). The kingdom government is responsible for issues such as defense and international affairs (Castillo, 1991), but, its major responsibility is considerably limited. Focusing only on Curacao, it can be concluded that Curacao has a parliamentary democracy which has a coalition government. Hossain (2009) claims that parties in a coalition government might agree on a fixed exchange rate simply as a way to settle conflicts about policy. History shows that the guilder (ANG) has been pegged to the US dollar since December 23^rd, 1971 by law. This decision was made by the central government. The main reason why they decided to peg the guilder to the US Dollar was because the central government wanted the Netherlands Antilles to remain an

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Table 4. GDP & unemployment rate (Source: CBS, 2009 & Island Territory of Curaçao, 2008)

2005 2006 2007 2008 Average

Nominal GDP growth (%) 4.9 4.5 6.3 8.9 6.2

Real GDP growth (%) 0.8 1.5 3.5 2.2 2

Unemployment rate (%) 18.2 14.7 12 10.3 13.8

attractive region for foreign investors and also because it wanted to protect the American- oriented tourist industry (Van Soest, 1978). According to the Central Bank (2010) the peg to the US$ results from the fact that most international transactions of the Netherlands Antilles are denominated in US$. Whether or not the exchange rate was pegged to prevent conflicts between governing parties is not clear. One thing is certain, since 1971 only a few politicians and well known specialists in this area (such as Mr. Ramon Chong, Chief of Economic Affairs, and Mr.

Emsley Tromp, president of BNA) proposed to change the peg to dollarization. They have been heavily criticized by the majority who are of the opinion that the current regime is working well, so there is no need to change it. This entails that the electoral system has not influenced the choice for the exchange rate regime since 1971.

In August 2010 the election for the new government of Curaçao took place. This means that Curacao’s current government, is at the beginning of a new electoral cycle at present. According to Carmignani, Colombo & Tirelli (2008) the political business cycle literature argues that politicians in the governing party(ies) manipulate macroeconomic policy before the election in order to produce an economic boom to win the next election. In addition, after the election, these politicians fix the exchange rate as a way to impose discipline on the economy, helping to prevent an inflationary spiral (Nordhaus, 1989; Alesina and Rosenthal, 1995; Keech, 1995 as cited in Carmignani, Colombo & Tirelli, 2008). However, this theory is not applicable to Curacao due to the fact that the government has not changed, nor attempted to change the exchange rate regime either, with the objective to influence the voting behavior of the population. Although, the politicians could have currently come with new ideas concerning a different exchange rate regime for the new constitutional status of Curacao, yet none of the parties did that during their political campaigns.

In order to evaluate the government’s temptation to inflate the GDP, growth rate and unemployment rates are necessary. Poirson (2001) claims that the lower past growth (or higher past unemployment), the higher the temptation the government faces to inflate, thus the higher its incentives to << tie its own hands >>. Based on table 4 the conclusion can be drawn that the Real GDP rate has a low growth of 2% and there is a high unemployment rate of 13.8%. This could lead to the governments’ temptation to inflate but until recently this has not been the case in Curacao. Furthermore, the governments’ hands are already tied due to the fact that the local currency is pegged to the US Dollar. However, they didn’t decide to increase the fixity of the exchange rate regime by, for instance, dollarizing its currency. The government did not adjust anything to the current exchange rate regime since the day it was established, in 1971.

3. Data analysis

Executive Summary

Contents

1. Introduction

2. Theoretical Framework