How Monetary Policy Shapes Tourism Demand in Pacific Island Economies

Tourism is often seen as a reflection of how confident people feel about the economy. When wallets are full and borrowing is cheap, more people book flights and hotel rooms. A new study by researchers from IIT Hyderabad, IIT Kanpur, the Reserve Bank of Fiji and the Central Bank of Solomon Islands explores this relationship to determine if monetary policy can influence the number of tourists that visit small island nations, and how much they spend once they get there.

The paper, titled “Role of Monetary Policy in Tourism Demand: Evidence from Pacific Island Countries”, examines data from 1995 to 2019 across countries such as Fiji, Samoa, Tonga, Vanuatu and the Solomon Islands. Using statistical tools like Granger causality and panel-regression analysis, the authors investigate whether changes in interest rates and money supply, the two key levers of monetary policy, affect tourism demand.

The study begins by confirming what many policymakers already suspect. Tourism and economic growth feed off each other. In the Pacific Island countries, tourism contributes heavily to GDP and employment. Fiji, for instance, draws more than half a million visitors a year and earns over half its export revenue from tourism.

Using causality tests, the researchers find that this relationship runs both ways. A stronger economy tends to attract more tourists by improving infrastructure, safety and services. At the same time, higher tourist arrivals boost growth through spending, job creation and foreign-exchange earnings.

Money Matters

The paper next focuses on how monetary policy fits into the picture. Monetary policy usually works through two main instruments: the interest rate, which affects borrowing costs, and money supply, which influences liquidity in the economy. The authors explore whether tightening or loosening these levers affects tourism.

The results show that higher interest rates tend to discourage tourism, but the effect is small and statistically insignificant. This means that even if borrowing becomes more expensive, it does not necessarily deter tourists from visiting or businesses from investing in the sector.

On the other hand, an increase in money supply, which typically means more credit and cash in circulation, has a positive effect, especially on tourism receipts. When central banks pump more money into the system, it may stimulate spending and investments in tourism-related infrastructure like hotels, transport and restaurants, leading to higher earnings from visitors.

Interestingly, while money supply boosts tourism revenue, it does not have a significant impact on the number of tourists. This suggests that while more liquidity helps improve quality and profitability of tourism services, it may not by itself attract additional visitors. Demand from tourists depends on broader factors such as connectivity, global income levels and destination reputation.

As most tourists visiting the Pacific Islands are from Australia, New Zealand or parts of Asia, the study also considers how global economic conditions influence tourism demand. By including the GDP growth rates of Australia and the US as proxies for global trends, the authors find that stronger foreign economies tend to encourage more outbound tourism. However, these global effects are not always significant.

The paper notes that the pandemic sharply exposed the vulnerability of Pacific Island economies. During lockdowns and border closures, tourism collapsed by more than 80% in some nations, wiping out jobs and government revenues.

In such settings, the ability of central banks to use monetary policy as a stabilising tool becomes even more important.

While the study finds only limited direct effects of interest rates, it highlights several ways in which monetary policy can indirectly support tourism. For example, lower interest rates can make it cheaper for businesses to borrow and invest in new hotels, resorts and airlines.

A looser money supply can help maintain liquidity during downturns, allowing tourism operators to stay afloat. Exchange-rate adjustments, often influenced by monetary decisions, also matter, as a weaker currency can make destinations more affordable for foreign visitors.

Coordinating for Stability

The authors argue that their findings should encourage closer coordination between central banks and tourism authorities. When monetary conditions are favourable, governments could use the opportunity to promote investment in tourism infrastructure. Conversely, during periods of monetary tightening, fiscal policies such as targeted subsidies or marketing campaigns should help offset the slowdown in demand.

The study also hints that monetary policy alone cannot drive tourism growth. Non-monetary factors, such as connectivity, safety and environmental sustainability, often play a larger role in attracting visitors. Still, understanding the monetary link helps policymakers design more balanced responses to shocks, especially in small economies.

This research fills an important gap in the literature. While previous studies have examined how tourism drives growth, few have looked at how central bank actions shape tourism outcomes in small island nations. The paper’s inclusion of both money supply and interest rate indicators, as well as global economic variables, provides a more complete picture of the tourism-monetary policy relationship.

In essence, the paper offers a reminder that tourism is not just about beaches and resorts; it is also about macroeconomics. Central bankers often focused on inflation and growth may not think of them as part of the tourism story. Yet, as this study shows, the flow of money through an economy can shape the flow of tourists across borders.