John Rolle on The Bahamas’ Fixed Exchange Rate and the First Nationwide Central Bank Digital Currency

David Beckworth: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University, and I’m glad you decided to join us.

Our guest today is John Rolle. John is the governor of the Central Bank of the Bahamas. He is a longtime veteran of the institution. He joins us today to discuss what it’s like to manage a central bank in a small open economy with a fixed exchange rate. He also joins us to discuss the SandDollar, the CBDC of the Bahamas, and other topics. John, welcome to the program.

John Rolle: David, thank you for having me. It’s a pleasure to be here.

Beckworth: It’s great to have you on. It’s great to have a central bank governor. We just had another one from the Riksbank. Now, that’s a small open economy central bank with a floating exchange rate, so it’s great to get your perspective because you’re a small open economy central bank with a fixed exchange rate. A different set of issues, some similar, some different, and it’s great to work through all of those implications.

I also want to let the listeners know, John, that I’m connected to you through a colleague of mine, Virgil Storr. He is a colleague of mine here at the Mercatus Center, and he said, “Hey, David, I got this great person for the podcast. He’s a relative of mine through marriage. I think you would love him.” I said, “Who’s that?” He said, “John—he’s the governor of the Central Bank of Bahamas.” I said, “Let’s do this.” He set us up, and I’m so grateful, John, you’ve taken time out today to talk about your central bank.

Rolle: David, thank you again, and let me say that I’ve taken a lot of opportunities, since we were introduced, to listen to the podcast, and they are very interesting, so you’ve found a new subscriber.

Beckworth: Oh, great. Fantastic. Good to know we’ve got listeners in the Bahamas. There you go, folks. All right. 

Central Bank of the Bahamas

Let’s talk about the Central Bank of the Bahamas. For listeners who are not familiar with the institution, maybe walk us through what it is, its main responsibilities, and how it’s different than a standard central bank in, say, in Europe, the ECB or the Fed.

Rolle: Just for context, in the Bahamas, we have a fixed exchange rate, so we have the Bahamian dollar that is tied one-to-one with the US dollar, and it has been that way since the 1960s. Before that, we were also a fixed exchange rate country, but we switched to the US dollar during the ’60s as the Bretton Woods system was coming to an end because we wanted to maintain the connection for tourism.

In the Bahamas, from that perspective, when you look at the central bank and what we do, our primary objective is maintaining that fixed exchange rate. Monetary policy is focused around the stability of the currency. We also have responsibility for regulating the banking sector with the financial stability and other implications that follow from that. As is common in central banking space, we also have a mandate for payment. Those are the three broad areas that we focus on in the Central Bank of the Bahamas. 

I think I should also say that we also have two other important regulators in the Bahamas, given the way we divide responsibilities. One of those is responsible for insurance, and then we have a nonbank securities regulator that also focuses on digital assets and the investment sector. Those are the other two regulators alongside the central bank that have some shared responsibilities for parts of the financial sector.

Beckworth: What is the benefit of the peg? You’ve got a fixed exchange rate. You’re effectively importing the Fed’s monetary policy because of that. What do you gain by pegging to the dollar, one-to-one?

Rolle: If you go back historically, it provided a seamless convenience for a tourism-dependent economy, meaning that it was not only a fixed exchange rate, but it was tied one-to-one to the US dollar. In an environment where physical cash circulated a lot more in the tourism space, and tourism is priced in dollars, that was a tremendous advantage and benefit for the Bahamas, being so close to the US, and also having an economy that, if you look at it from the theoretical sense, we look a lot like an optimum currency area, insofar as being near to the United States.

The challenges that you might typically have in having a fixed exchange rate and how you could have your misalignments, those pressures don’t present themselves to that extent for us. Being tied or pegged to the US, predominantly trading with the US, you also benefit from the US monetary policies and the outcomes that they achieve in terms of low and stable inflation. We typically import our inflation experience from the United States. We are also in a situation where we have a very, very closely synced economy to the US in terms of how our economic cycles would look, give, or take slight differences in terms of average growth rates. We’re very synchronized and correlated as economies.

Beckworth: You have to defend the peg, or maintain the peg—maybe it’s a better term—and that requires you building up a big war chest of foreign exchange reserves. Tell us about that.

Rolle: Yes. The way the system works is that, in the case of the Bahamas, by law, we have to maintain foreign reserves to back the domestic currency liabilities of the central bank. The law says that we must hold at least 50% of any local currency liabilities that the central bank issues. We must hold at least 50% equivalent in foreign currency.

I think the correct terminology is the demand liabilities of the central bank. When you think about the demand liabilities, you’re also considering the deposits and other reserves that commercial banks might hold with the central bank in addition to the currency that’s in circulation. In recent times and traditionally, we’ve always done much better than just the 50% coverage. As a matter of fact, the Bahamas has gone through quite a lot of episodes recently where the coverage has been over 100%, but it is really the ability to maintain that backing for the currency that helps you maintain the fixed exchange rates, the backing and the balances maintained by monitoring how you source foreign exchange versus how you use foreign exchange. 

Typically, in a pure textbook sense, the only way you create any divergences between how much demand liabilities the central bank has, like in the Bahamas and its reserves, is when the central bank prints money in a textbook sense or to the extent that the central bank also may extend credit to the government. Therefore, the central bank is putting additional demand liabilities out there that it did not source by exchanging local currency liabilities for foreign currency. It is really also the ability within that framework to somehow manage the total amount of exposure that a central bank maintains over time or comes into over time relative to lending to a government.

Beckworth: It’s so fascinating to hear this. In international economics—and you were at the IMF, so you probably thought about this a lot in your previous career and your work and all your time at the Central Bank of the Bahamas—we talk about this macroeconomic trilemma, or the unholy trinity, where a country may want to do all three goals, but only two of these goals are possible. They may want to have free capital flows, they want to have its own domestic sovereign monetary policy, and a fixed exchange rate, but you only can do two of the three. You have picked, in the Bahamas effectively, fixed exchange rate and then, I guess, free capital flows. 

Rolle: We have the capital controls. Again, it looks a lot like the textbook case in the sense that you can’t have perfect capital controls, fixed exchange rates, and independent policies. So to achieve what we’ve achieved, we have to have some means of moderating, if not fully, to some extent, controlling the capital flows. In this case, the emphasis is really on how we manage, particularly short-term capital flows, because looking at the long-term capital flows which tend to feed into investments, we focus on ensuring that those types of flows are sustainable and that they are actually going to help boost our economy’s ability to earn foreign exchange over the longer term.

Beckworth: As a central bank governor, how do you measure the stance of policy in your country? I know you’re supposed to keep your rates pretty close to what the Fed’s doing. You’re pegging your dollar to what the US dollar is. Are there indicators that you look to besides those in terms of the heat of the economy? Oh, the economy is getting a little too hot, too warm. Do you look at inflation, money measures? What indicators do you look at, month to month, to see where the economy is and maybe you need to step in and do something?

Rolle: Because it reduces to ensuring that you have the adequate foreign reserve backing for your currency, the focus really is on the trends that are influencing either your foreign exchange inflows, and that’s predominantly how the tourism sector is doing and how the other sectors that maybe are earning foreign exchange are doing. You juxtapose that with where are the demand sources coming from for foreign exchange. There are two: Either it’s coming out of the natural income path, or it’s coming out of credit creation.

For us, maintaining that balance is really making certain that there is a sustainable pattern of credit expansion and, to the extent that the credit expansion is fueling additional call on the use of foreign exchange, you’re able to monitor whether you have any pressures that you have to address. Now, the interesting thing about the economic setup that the Bahamas has—and it’s similar in many of the very small open economies, fixed exchange rate, limited diversification, even in some of those that might have flexible currencies—is that your policies have to be pro-cyclical.

That’s not necessarily the best because pro-cyclicality means that when your foreign exchange-earning sector weakens, and your supply of foreign exchange starts to reduce relatively, unfortunately. The response is not to stimulate because then you would be stimulating the demand side of your economy if you’re set up like the Bahamas. You have to go in and you have to try and moderate the demand.

The pro-cyclicality typically means that if you don’t have the buffers, a central bank like the Bahamas would be forced to make economic downturns more aggravating than otherwise. We get fully what it means to say you have buffers because if you have buffers, then it means that you can tolerate demand being ahead of how your foreign exchange sector might be doing in a temporary downturn.

Beckworth: As a central bank governor, when you have to make these tough choices, and you have to do monetary policy, again, some of it’s automatic because of the peg, but some of it is choices you’ve got to make explicitly as well with discretion. It’s important to have independence as a central bank. How does that operate in the Bahamas? Are you given the independence that you need to make tough calls?

Rolle: I like this conversation about central bank independence, which is different from a conversation about monetary policy independence in a cross-border sense. I think it’s really the interdependency between a central bank in the Bahamian case and what’s happening on the fiscal side because, again, textbook sense, the fiscal side matters much more in a setting like the Bahamas. There’s a very close collaboration and coordination between the central bank and the fiscal side.

One of the ways that collaboration looks is not so much whether we have a say in terms of the fiscal deficit target, but we definitely have a say in terms of advising the government as to what are the sustainable ways they’re financing a fiscal imbalance. To the extent that you have a fiscal imbalance that might be putting pressure on demand for foreign exchange, then it also means that you sometimes have to get the fiscal authority to see how certain imbalances are only sustainable or financeable if you have access to foreign currency financing.

That really sums up the experiences that countries like the Bahamas had during the pandemic and in some of the other episodes where you had very strong external shocks in terms of avoiding the pro-cyclicality, but recognizing that even fiscal stimulus needed to have a financing source that was external.

Beckworth: Maybe independence is the wrong word here, but a close working relationship where both parties understand what needs to be done in terms of—

Rolle: Absolutely.

Beckworth: —restoring balance. Yes.

Rolle: I think, to be fair, too, when you look at the monetary policy experience in the advanced economies too, there’s an increasing appreciation that even if the monetary side has certain focuses, it still depends on what’s happening on the fiscal side. If there’s a tension, the monetary policy side loses some of the flexibility in terms of how it might focus as to, perhaps, compensate or correct for some of the fiscal pressures.

Beckworth: No, absolutely. A basic macroeconomic accounting identity is the intertemporal government budget constraint, which combines central bank and the fiscal side together. It really, at some level, is a bit of a mirage to think they’re truly independent from each other. In the long run, they constrain each other. There’s no doubt about that. You’re right. We see that more clearly in moments like we’re in where fiscal pressures do not look very hopeful, at least in the US and some advanced economies over the next decade.

Just a concrete example: As we run larger and larger primary deficits, it’s going to be harder and harder for the Fed to want to independently set that interest rate because that interest rate then affects interest payments on the debt level. It’s hard to completely separate them. Even in textbook New Keynesian models, it assumes in the background the fiscal house is in order so that you can have this independent central bank. This is great to hear your perspective.

Rolle: One other point related to this is that when you look at an inflation-targeting regime, the outcome is that if you don’t achieve the sustainable path, you’re dealing with an inflationary outcome that’s not satisfactory. For us, it’s not inflation; it’s a loss of foreign reserves. We do see that play out if we don’t achieve the sustainable level of coordination between the monetary and the fiscal.

I must say that when I look at an economy like the Bahamas, and even to some extent, I like to use the experience in Barbados—even though Barbados has gone through some severe austerity experiences in the recent decade—that there tends to be a very strong national consensus to that monetary policy objective around the currency’s stability and an appreciation often that when austerity or the equivalent is necessary that you accept it just to deliver on the, in this case, the currency stability. You do see that play out.

It means that even at the political level, the more interesting conversation is who does a better job of supporting those objectives. I think that’s something that I’ve always found admirable about the Bahamian case.

Beckworth: That is so interesting. Maybe another way to frame this, at least the way I’m seeing this is, you see, in real-time, more clearly, the link between fiscal policy and monetary policy. The consolidated government budget constraint is a real thing. It just so happens in an economy like yours, it’s very real, very binding all the time.

Rolle: Very much.

Beckworth: It’s easier for you to see it than, say, someone in an advanced economy where it takes longer, maybe it’s a little more hidden, but you are a great case study in why it matters. 

The Economy of the Bahamas

John, this has been a fascinating conversation about the importance of both fiscal policy, monetary policy, how they work together hand in hand, and how you see this in real time in the Bahamas. Let’s talk about the Bahama economy a little bit more. We’ve touched on it, but it is a unique economy, a lot of tourism. How does that affect your job, the structure of the Bahama economy?

Rolle: In some ways, it simplifies the work, but it also highlights the vulnerabilities that you have as an economy because it means that when we look at what the outlook is for tourism, we have a fairly good appreciation for what’s going to drive the year-over-year fluctuations in our export earnings sector. We’re able to anticipate how the stance of monetary policy might need to be modulated in that context, and it means that you can focus on the US and the trends that manifest themselves in the US.

It does mean that, as an economy where you have significant dependence on the US market for business—in this case, I think at least four-fifths of our business is US-sourced—it means that you are very much influenced by the consumer sentiment element of the US economy, and how that filters into travel, demand, and spending. That is concentrating the kinds of vulnerabilities that we experience because of the US-centric nature of our tourism. The upside, David, is that we’re close to the US, and so it’s also easy for Americans to get to the Bahamas.

Beckworth: Yes, and lots of cruise ships stop by the Bahamas, and you guys get a lot of tourism there. That’s the primary driver, but you guys have also been diversifying into other sectors too, correct?

Rolle: Yes. Financial services are important for the Bahamas. In addition to what happens in the domestic space, the Bahamas has historically also provided international financial services. There is an element of our banking sector that is focused on providing banking services to non-Bahamians or nonresidents, and the bigger chunk of what happens in our nonbank securities sector is around digital assets, international portfolio investment services, and those as well tend to be directed more so at non-Bahamians.

The financial services sector is significant because it employs a lot more concentration of high-skilled individuals, accountancy, law, and the like, and those are professionals that typically earn much higher incomes on average than those that are in tourism, but still tourism is the bread and butter insofar as the bulk of your foreign exchange inflows are concerned.

Beckworth: What happened in the Bahamas, say, during COVID when we had the global slowdown? How did that affect the economy then?

Rolle: COVID was quite an interesting experience because, if you are a tourism-dependent country, it meant that that sector was at a complete standstill, and so what we experienced in the Bahamas was, in real terms, about a 20% to 25% contraction in economic activity over that period, and that is concentrated in 2020. I think as we progressed through 2021, you started to have a bit of a recovery. Because again, it was tourism-driven, we were not fully recovered until around about the third, fourth quarter of 2022 and going into the first quarter of 2023.

It was quite a setback, but all things considered, I think there was an upside to that because then it also increased the interest that people had in making investments in countries like the Bahamas in second homes. I think when I look at what’s happening right now in the Bahamas and the strength of our economy, we are still growing above medium-term potential because there’s still a lot of investment going on in residential tourism, and some of that interest is sparked by the interest during the pandemic in wanting to live in places like the Bahamas and to have, I guess, more spacious surroundings, given the COVID experience.

Beckworth: You benefited from the post-COVID boom that took place in the US afterwards. You’re a recipient of it.

Rolle: Absolutely, yes.

Beckworth: I’m curious, how did the government handle, though, the shutdown? In the US, we had massive fiscal transfers, and so you think of the inflation as one of the prices we paid for insurance of sorts from the government. Like fighting a war, sometimes you’ve got to pay through higher inflation. How did the government there handle a massive shutdown? You said 20%, 30% shutdown. I’m sure unemployment must have soared; people were suffering. How did your country handle that?

Rolle: I like to term it that we had to focus on stabilization. Stabilization was, I think, the most of what we could do. It looked like fiscal stimulus, but there was no expansionary bent to the focus in the Bahamas, but just for a government keeping its expenditures relatively stable as well as providing basic social support. The Bahamas incurred significant deficits as a percentage of GDP, and I would say, in terms of the fiscal damage, we’re on a path that is easily more than half a decade in terms of the recovery and getting the fiscal debt-to-GDP ratios back below the 70% range or getting it down into the 60% range.

The pandemic struck at a time when the Bahamas was already trying to get focus on a medium-term trajectory to get the public indebtedness below 50% of GDP. We still have very ambitious goals there, but the timelines are radically shifted. The pandemic was one of those countrywide shutdowns. In some ways, it reminded us of the kinds of shocks that we also get from the hurricanes and the climate-related vulnerabilities that are increasing.

Financial Stability in the Bahamas

Beckworth: Fair enough. Going back to the financial system you mentioned earlier, tell us more about it. Are there any risks to it? What do you think of when you think of financial stability? What sectors, what type of institutions are you looking at?

Rolle: From a personal perspective, when I have conversations about financial stability risk in the Bahamas, I think that in the near to medium term, we’re in a good position in the sense that we have a highly capitalized banking system. As a matter of fact, if you’re using the Basel methodology, our domestic banking system has a capital ratio, risk-weighted capital ratio, above 30%.

Beckworth: Wow, 30%. Oh, man.

Rolle: I think, and I’ve expressed it publicly, that if you’re looking at it from a financial stability point of view, over time, we want to see those ratios come down a bit because we see that as being capital that the banks are sitting upon and capital that they have to put to work. Banks also have lots of liquidity that they are not under any pressure right now to use. If you’re thinking about it from a financial stability point of view, you want to put yourself on the path where you can siphon some of that out of your system gradually so that when the exuberance returns, it doesn’t create the unsustainable explosion in credit.

That’s not where we are today, but in my view, into the medium term and beyond, one of the focuses for a central bank like the Bahamas is how do you get the capital ratios down to a bit more of a comfortable level. This is happening also because we don’t yet subscribe to the countercyclical buffers. We find it more convenient to just focus on having a good buffer. I think we can moderately target lower levels over the medium term. That defines a strategy for us. It is something we can do, David, because capital controls do allow you to manage the unwinding of some of these overhangs at a more comfortable pace than might be the case otherwise.

Beckworth: That’s still a really high capital ratio compared to the US, and that’s pretty remarkable you’ve built up that big of a buffer. Now, there are some people who would say, “Keep it, John. Keep it. We want that.” Others would say, “That’s actually a real cost to the economy. That’s potential economic growth you’re not investing in.” 

Let’s go to the probably best-known case of financial stability issues in the Bahamas, and that was the FTX collapse a few years back. Tell us your perspective on that story. What happened? What are the lessons learned for regulation of digital assets and financial stability?

Rolle: I think when you look back at the Bahamas’ experience with the FTX collapse, it’s essentially reduced to a case of fraud. With the best of regulations, what matters is how regulators will intervene and resolve those cases. What was important for the Bahamas, I think, was that we had a regulated space, and in that regulated space where resolution was important, we were able to tap in even to our international network of regulators, including the United States, and secure the interventions and to secure the protection of the assets that was necessary.

Coming out of that, it was ultimately resolved, I think, to the extent that the capital was fully recovered insofar as what the initial put out of investors, so that was a good thing. I think one of the important lessons there is having the regulated space. In terms of the iterations that have happened since then, I think it has also increased the focus on putting in a lot more of the prudential safeguards around digital assets.

In a regulated securities case, there’s a lot of focus on investor protection and market conduct, but you begin to appreciate, when you look at some of the financial market reactions to what happened, that you also have to increase the emphasis on the prudential aspect of how these arrangements are structured. You see that, I think, emphasis come across a lot in terms of how, say, the United States is approaching stablecoins, as well as the way in many countries, the focus is a lot more on the digital assets that have fiat or sovereign instruments somewhere in the mix as opposed to those algorithmic instruments that could be riskier.

I think also there’s an increasing appreciation for the distinction you make between privacy, confidentiality, and still the sort of visibility that is needed to counter money laundering and financial crimes. All of those really matter. A lot of those aspects were part of the Bahamian system even before this experience.

Beckworth: Speaking of digital assets, you have this wonderful thing there called the SandDollar. With a name like that, it’s hard not to love a SandDollar, right? That’s your CBDC, and it’s one of the early CBDCs. You guys were out the gate, I think, long before most other countries that have done that. Why did the Bahamas go down the path of adopting the SandDollar?

Rolle: Because we needed to address, and we are continuing to address, some medium- and long-term issues in terms of how we look at financial inclusion, how we address having more resilience in our financial system, as well as how you broaden the space in which payment services providers can function and operate. When I say it’s a journey, what is important for us, I think, in terms of completing that process is building out a lot more of the ecosystem, including getting the government fully inserted into that space.

Financial inclusion for us matters because we are an archipelago, very sparsely populated. The infrastructure costs are very high. In a very rural setting, you’re not going to get a lot of the physical delivery of financial services. This is really a part of the process of making services accessible more through the digital channels, using the experience to think about the practical side of how does a person get an account. It’s digital onboarding. How do you deal with the AML and other safeguards around how individuals onboard?

We have the benefit of dealing with all of that and then identifying what would be some of the early use cases for how persons can use digital wallets. What we focused on, some of it, I think, sequentially, we didn’t look at, at the outset, but we made certain, when you look at what we have today, that it is integrated into our automated clearinghouse system. The SandDollar does link up with the banking system. It’s faster than the banking system in terms of moving the funds within the space, but it does not have the benefit yet of the merchant ecosystem that is important, I think, to see the full adoption possibilities around peer-to-peer payments or P2B or P2G payments.

We have a very robust framework now to address the ease at which individuals, from a risk basis, can sign up for basic financial services, and for some of the reforms that are ahead of us, we will be able to now address more interlinkages and access to the merchant ecosystem. I think that will allow us to begin to see more of the use cases for a CBDC that we haven’t yet tapped into.

Beckworth: You were responding to the unbanked in the country. Is that what it is? There’s a missing market there that you wanted to fill?

Rolle: It’s a combination because being banked in an archipelago or being banked in a very, very rural community sometimes can still feel like it’s not truthfully financial inclusion because the conveniences that you might have for those services. One of the gaps that we have to fill is how easy it is for individuals, even if they have access to existing services, to just transfer funds on a peer-to-peer basis or on a P2B basis. Being more digitally connected, which we’re able to accelerate through this process, helps those individuals, even if they already have accounts.

I think, in the case of the Bahamas, a lot of the persons in the population who need the benefit from a more inclusive financial system need that, even if they have bank accounts. There are those who are unbanked or at least getting started. They need increased access. What we’ve achieved is that, as we started to have nonbanks enter into the payment space, you immediately had an interoperable platform for those entities to operate.

Because they’re more nimble at how they apply FATF-compliant AML standards for onboarding and the like, they also are more agile in terms of onboarding individuals who may not yet have facilities. Those individuals now also have access to the payments and transfers that are originating from the banking system.

Beckworth: Is this a tokenized CBDC? Is it truly like, if I’m in the Bahamas, I have the SandDollar, I can go and spend it and give it directly to someone else, or does it go through an intermediary, through the central bank’s balance sheet?

Rolle: You can transfer it peer-to-peer, no issues. The central bank does maintain the ledger, but the central bank does not provide the retail services. The financial institution still has to provide the wallet, and what those wallets look like, it’s up to them. They are a very important link in terms of providing the services. Again, that’s one of those deliberate policy design elements of a central bank digital currency. It might impede the rate at which you achieve certain of your adoption outcomes, but then you recognize as a central bank that you’re not in the business of providing retail customer services. You allow things to progress at the pace that the private sector can do it.

Beckworth: Yes, and I’m sure you must have got some pushback from the banks as well, “Hey, this is our space. Let us develop the infrastructure for that.”

Rolle: Interestingly, too, in our setting, what the CBDC illustrates, as well as what some of your required payment infrastructure do on the whole, is that what you define as a public good starts to look different as the financial space becomes smaller and you can’t achieve the economies of scale. In some cases, even if you look at other countries where they’ve implemented fast payments or instant payment systems, central banks find that they have to lead on some of the investments because you don’t get the responsiveness from the private sector because it doesn’t seem to have the same return appeal from the outset. I think, to some extent, that’s a part of what we have in the Bahamas, even though, in this case, we would have started with the central bank digital currency. 

Now, what we’re realizing, David, and I think if you listen very carefully what’s happening in the wholesale space and in the tokenized deposit space, is that there is complementarity between the aspects of the payments infrastructure that the central bank provides. In many more cases now, it seems to be a complementarity that’s looking at wholesale CBDCs and tokenized deposits, but we think in terms of some of the resilience that we need in the Bahamas, some of that complementarity is also going to exist between how the instant payment system for the Bahamas functions from a resilience point of view with a CBDC alongside it, and that’s just a very roundabout way of saying that we think, at some point, this issue of offline payments means that you will need a unifying instrument in there that looks a lot like digital fiat.

Beckworth: Again, just to be clear, this CBDC can go peer-to-peer, person-to-person, without the Central Bank of the Bahamas knowing what’s happening. You can transact it. It’s still a liability on your books if the action’s happening somewhere else, and you’re not seeing what each person is spending or who they’re giving it to directly.

Rolle: No, we’re not seeing that. Now, the system does have the anti-money laundering and other safeguards in there. So if you’re a payment provider, the system is configured for you to have the visibility as a payment provider that you need to any client that has a wallet. That’s what’s important from a privacy versus financial integrity perspective.

Dollar-Based Stablecoins in the Bahamas

Beckworth: What about the prospects of dollar-based stablecoins? We hear a lot about that now. For example, Tether. I know Tether is a dollar-based stablecoin that’s used widely in emerging economies. It’s used widely outside the US. Circle, it’s used a lot with crypto companies. Do you see the presence, the footprint of dollar-based stablecoins there in Bahamas, and how that will impact the ultimate success of the SandDollar?

Rolle: I think, on some level, there’s been hopes internationally that they would have seen greater returns, I think, in the cross-border retail space for stablecoins, and hopefully, it’ll come at some point. If you’re a country like the Bahamas and you’re dependent on exporting international services, and you’re looking at it from the payment side, then the innovators will have to think about how they tap into stablecoins to increase the potential expenditure that they take on from tourists.

I do think that medium and long term, we have to be progressive and open to how stablecoins can find their way into the payment space. Whether, outside of payments, stablecoins have the same type of traction in every country, I think it’s going to be a matter of how the citizens and the residents view the kind of arbitrage or safety they need in terms of capital controls or political or other risks that they may be managing in some country.

That aspect of stablecoins and how it could look in the Bahamas, I don’t see it as something that is imminent, and to the extent that there might be interest in it, our system of capital controls do not prevent residents from investing in those types of activities. It just means that they go through a different channel to do so, similar to the channels that they would go through to make any type of portfolio investments abroad. By policy, what we said is that if it is a US dollar or nonlocal currency digital asset or stablecoin, then an individual who wants to access it on our side, as a portfolio transaction, would go through the regulated channels that they would for any type of portfolio investments.

I think that will look different when we get to the point where a tourist is coming to the Bahamas and making a payment with a stablecoin, or a cross-border P2P transfer is coming to someone that is going to use it for payments locally. What we will need to think about is the off-ramps, because the off-ramps seem to be still a challenge in the developing countries where the stablecoins are coming in, where there are some remittances and the like. If we don’t address it, we may not get the envisioned benefits of the instrument, which is supposed to make it cheaper, as opposed to the remittances and transfers.

Tokenized Deposits in the Bahamas

Beckworth: That’s the irony of it. At least the current technologies, the on/off-ramps, actually added a cost. Even though it might be cheaper on the rails, often on the rails, you have the extra time and cost involved. Related to that, John, you mentioned tokenized deposits. Banks themselves may get involved in tokenized deposits. That might also be another innovation in the payment space. Do you see that being an important part of Bahamas’ future payment system?

Rolle: I think if you get a truly interoperable global payments infrastructure, lots of these alternatives could coexist. The very small size of Bahamas’ banking sector means that in our domestic case, we’re probably more likely going to be on the receiving end. If we’re part of a global network, then it might be the case that cross-border settlements involve some of those types of transfers. It seems that space is getting more attention from the very, very large financial institutions.

It may well be that the experience for countries like the Bahamas looks like a different type of correspondent banking relationship, where the settlement or the payments are now using these tokenized instruments rather than whatever methods are being used now.

Future of the Financial System and Economy in the Bahamas

Beckworth: Let’s move on and talk about the future of the financial system and the economy in the Bahamas. Tell us about the future of handling natural disasters, hurricanes, climate risks. You mentioned earlier that’s something that you guys experience somewhat regularly. How do you think about that? How do you plan for that? How do you incorporate that into your financial stability plans moving forward?

Rolle: It’s interesting because as stress-testing methodologies improve, we’re learning how to refine the approach to incorporating climate risk into the stress-testing model. Definitely from that perspective, that is an area where I think, in the case of the Bahamas, we are going to increase in terms of our capacity. A big part of the credit exposure in our country like the Bahamas, is understanding where the risk could lie in terms of potential damage from hurricanes or potential damage from sea level rise.

There is definitely going to be work there in terms of making certain that credit quality is not diminished as climate risks escalate. We also have immediately a lot of the resilience issues that come from the disruption in terms of how quickly one recovers financial services, payments, and basic infrastructure after a setback. That starts to look a lot like how you build a resilient digital infrastructure.

We think that becomes very important for an archipelago like the Bahamas. There will be a lot of emphasis there. We also focus on how financial institutions display agility in managing their credit portfolios with their customers. Suddenly, they are experiencing a setback from a natural disaster. You see, in terms of the way regulatory guidance may be out there, that you expect your financial institutions to have those built-in mechanisms to help customers get temporary reprieve or other types of accommodations after natural disasters.

The business continuity aspect of it is very important. In relation to the business continuity and the fact that there is the digital element, it is recognizing that if you want to now factor in inclusivity, you have to make certain that the users of financial products and services have some basic access to the data services. Access to data has to now filter into how we think about the resilience and the recoverability aspect of financial services after disasters.

Beckworth: That’s really interesting. I was just talking to someone about the importance of physical cash. In fact, it was the central bank governor of Sweden. They pushed really hard for digital currency, and then they learned sometimes it’s good to have physical cash. What you’re describing, I think what I hear you saying is because you do have these big natural disasters, you need to have some kind of payment system that’s robust, that makes the economy resilient so you can recover quickly. Having a SandDollar that can operate offline, so if someone’s stranded on an island somewhere, he still can transact with his SandDollar. That’s a part of this resiliency work that you’re doing.

Rolle: Yes, and the qualification also is to appreciate that I don’t think anyone expects that anytime soon, perhaps over the next few decades, that physical cash is going to disappear. Ironically, in a case like the Bahamas, some of the challenges that we have to address is also improving access to physical cash logistically. We think that there are possibilities where, again, using a central bank digital currency or other public goods instruments, that we can also perhaps, in the near to medium term, improve the infrastructure for access to physical cash. If people have the comfort that the physical cash access is improved, it could help even more with digital adoption, knowing that you have the substitutability and the access.

There may need to be, I think, that cash safety net, I like to call it, in terms of how people view increasing their dependence on the digital instrument. Over time, the comfort might increase in terms of distancing yourself relatively more. It is very costly in the Bahamas, logistically, to supply the archipelago with physical cash. There are parts of government operations in some of those islands where, because the financial infrastructure is not as advanced, the government still operates on a cash basis.

The government is one of those users of the system that is also anxious to see more connectivity on the digital end. Central bank now suddenly plays another collaborative role in terms of working with the government to help the government build those types of systems.

Small Open Economy Central Banks

Beckworth: John, this has been so fascinating. I want to leave you with one last question. That is this: What do central bankers, economists, and other observers in advanced economies get most wrong about their understanding of a small open economy central bank like yours?

Rolle: I think part of it is understanding that when you get down to very, very small economies, that there is no one size that fits all, and appreciating that the space in which central banks are sometimes compelled to operate in smaller economies increasingly looks more expansive than just focusing on the core monetary policy issues. For example, getting the innovations needed in the digital space and how you manage what a central bank might do versus reliance on private sector, that starts to look and feel different as you get into smaller and smaller economic spaces.

I think, too, the very valuable focus on monetary policy, inflation targeting, all are very interesting, but in many cases, for the smaller economies, they still reduce to maintaining incredible currency stability, focusing on adjustments that look a lot more like austerity than exchange rate correction, because those then go counter to the inflation. It means that even where you have certain of those flexibilities, in practice, it may not look very much different than the countries that are still small and clinging to those pegs.

It’s important to understand, I think, the rationale and the good rationale behind why, in a lot of these small country settings, those pegs still matter and how countries need to judiciously manage the capital accounts so that you can sustain those pegs.

Beckworth: With that, our time is up. Our guest today has been John Rolle. John, thank you so much for coming on the podcast.

Rolle: Thank you, David, and it has been a pleasure.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth, and follow the show @Macro_Musings.