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A Fiscal Insurance Proposal for the Eastern Caribbean Currency Union

Intergovernmental Group of Twenty-Four | March 8, 2004

By Laura dos Reis

Abstract: This paper proposes the implementation of a fiscal insurance mechanism for the member countries of the Organization of Eastern Caribbean States (OECS). Fiscal insurance would be important to cushion against transitory shocks and would also reinforce the union’s long-term viability. These countries are already linked together through a common currency, administered by the Eastern Caribbean Central Bank (ECCB) under a currency board arrangement. Preliminary evidence suggests that volatility in fiscal accounts would be reduced if countries join a fiscal insurance arrangement through the possibility of cross-compensations under a risk-sharing scheme. Moreover, since the regional fluctuations of output and government revenues are not significantly correlated, a fiscal insurance mechanism can take advantage of these asymmetries and lead to welfare gains for all members. The paper presents numerical simulations for partial and full insurance schemes and quantifies the required size of the initial buffer. It also simulates what would be the welfare gains in terms of lower volatility and lower initial buffer as compared to self-insurance.

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