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A PROPOSED MONETARY REGIME FOR SMALL COMMODITY-EXPORTERS: PEG THE EXPORT PRICE (“PEP”)

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Small commodity-exporting countries often face significant economic volatility due to fluctuations in global commodity prices. These fluctuations can lead to unstable national incomes, exchange rate volatility, and inflation, posing challenges for economic stability and growth. Traditional monetary regimes, such as floating exchange rates or fixed pegs to a major currency, often fail to address these issues effectively. This study proposes a new monetary regime for small commodity-exporters: Peg the Export Price (PEP). By pegging the national currency to the price of the primary export commodity, this regime aims to stabilize the economy, reduce volatility, and promote sustainable economic growth.

The question of the optimal monetary regime for small open economies is still wide open. On the one hand, the big selling points of floating exchange rates – monetary independence and accommodation of terms of trade shocks – have not lived up to their promise. On the other hand, proposals for credible institutional monetary commitments to nominal anchors have each run aground on their own peculiar shoals. Rigid pegs to the dollar are dangerous when the dollar appreciates. Money targeting doesn’t work when there is a velocity shock. CPI targeting is not viable when there is a large import price shock. And the gold standard fails when there are large fluctuations in the world gold market. This paper advances a new proposal called PEP: Peg the Export Price. Most applicable for countries that are specialized in the production of a particular mineral or agricultural product, the proposal calls on them to commit to fix the price of that commodity in terms of domestic currency. A series of simulations shows how such a proposal would have worked for oil producers over the period 1970-2000. The paths of real oil prices, exports, and debt are simulated under alternative regimes. An illustrative finding is that countries that suffered a declining world market in oil or other export commodities in the late 1990s, would under the PEP proposal have automatically experienced a depreciation and a boost to exports when it was most needed. The argument for PEP is that it simultaneously delivers automatic accommodation to terms of trade shocks, as floating exchange rates are supposed to do, while retaining the credibility-enhancing advantages of a nominal anchor, as dollar pegs are supposed to do.

1.2 Statement of the Problem

Small commodity-exporters struggle with economic instability due to volatile commodity prices. Existing monetary policies do not adequately mitigate these fluctuations, leading to financial uncertainty and impeding long-term economic planning and development. There is a need for an alternative monetary regime that can provide stability and foster economic resilience in these countries.

1.3 Objectives of the Study

The main objective of this study is to determine the effectiveness of the Peg the Export Price (PEP) monetary regime for small commodity-exporters. Specific objectives include:

i. To evaluate the impact of PEP on economic stability in small commodity-exporting countries.

ii. To determine the effect of PEP on exchange rate volatility.

iii. To find out how PEP influences inflation rates in small commodity-exporting economies.

1.4 Research Questions

i. What is the impact of PEP on economic stability in small commodity-exporting countries?

ii. What is the effect of PEP on exchange rate volatility?

iii. How does PEP influence inflation rates in small commodity-exporting economies?

1.5 Research Hypotheses

Based on the research questions, the hypotheses are:

Hypothesis I

H0: There is no significant impact of PEP on economic stability in small commodity-exporting countries.

H1: There is a significant impact of PEP on economic stability in small commodity-exporting countries.

Hypothesis II

H0: There is no significant effect of PEP on exchange rate volatility.

H2: There is a significant effect of PEP on exchange rate volatility.

Hypothesis III

H0: There is no significant influence of PEP on inflation rates in small commodity-exporting economies.

H3: There is a significant influence of PEP on inflation rates in small commodity-exporting economies.

1.6 Significance of the Study

This study is significant as it explores a novel approach to economic stabilization for small commodity-exporters, potentially offering a viable solution to the persistent issues of economic volatility and instability. By implementing the PEP monetary regime, these countries could achieve more predictable economic conditions, fostering an environment conducive to sustainable growth, investment, and development. Additionally, this research contributes to the broader field of economic policy and monetary theory, providing insights that could inform policymakers, economists, and scholars.

1.7 Scope of the Study

The study focuses on small commodity-exporting countries, examining the potential effects of the PEP monetary regime on their economic stability, exchange rate volatility, and inflation rates. The analysis includes both theoretical assessments and empirical evaluations using data from selected countries that predominantly export a single commodity.

1.8 Limitations of the Study

The study may face limitations such as data availability and quality, particularly for less-developed countries with limited economic reporting. Additionally, the unique economic contexts of different countries may affect the generalizability of the findings. The implementation of the PEP regime also requires cooperation from international trading partners, which may present practical challenges.

1.9 Definition of Terms

Peg the Export Price (PEP): A monetary regime where a country's currency value is pegged to the price of its primary export commodity.

Economic Stability: A condition in which an economy experiences steady growth, low inflation, and reduced volatility in economic indicators.

Exchange Rate Volatility: The degree of fluctuation in the value of a currency relative to other currencies.

Inflation Rate: The rate at which the general level of prices for goods and services rises, eroding purchasing power.

Commodity-Exporting Countries: Nations whose economies rely significantly on the export of raw materials and primary goods.

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