Terms of Trade Shocks in an Intertemporal Model: Should We Worry About the Dutch Disease or Excessive Borrowing?

26 Pages Posted: 20 Dec 2006

See all articles by Karlygash Kuralbayeva

Karlygash Kuralbayeva

King’s College London

David Vines

University of Oxford - Balliol College - Department of Economics; Australian National University (ANU); Centre for Economic Policy Research (CEPR)

Date Written: October 2006

Abstract

This paper analyzes the impact of terms of trade and risk-premium shocks on a small open economy in an intertemporal, Dutch disease model, with international capital mobility. It is shown that when the economy experiences a permanent improvement in the terms of trade, the Dutch disease effect (real exchange rate appreciation) goes away in the new steady state, while the economy experiences de-industrialization even stronger than in the short-run. Second, a permanent improvement in the terms of trade coupled with a permanent reduction in the risk-premium leads to pro-industrialization and a real exchange rate appreciation. The mechanism behind appreciation of the real exchange rate in the long-run is different from the Dutch disease story. It occurs because reduction in the risk-premium reduces the costs of the production in the economy, and because (non-oil) traded sector benefits more from cheaper capital than the non-traded sector. The economy also accumulates more debt in response to these two shocks in the long-run.

Keywords: Capital inflows, Dutch disease, external debt, optimizing models, overborrowing, real exchange rate

JEL Classification: E44, F32, F34, F41

Suggested Citation

Kuralbayeva, Karlygash and Vines, David, Terms of Trade Shocks in an Intertemporal Model: Should We Worry About the Dutch Disease or Excessive Borrowing? (October 2006). CEPR Discussion Paper No. 5857, Available at SSRN: https://ssrn.com/abstract=952776

Karlygash Kuralbayeva

King’s College London ( email )

Strand
London, England WC2R 2LS
United Kingdom

David Vines (Contact Author)

University of Oxford - Balliol College - Department of Economics ( email )

Manor Road
Oxford, OX1 3BJ, Oxfordshire OX13UQ
United Kingdom
+44 1865 271 067 (Phone)
+44 1865 271 094 (Fax)

Australian National University (ANU)

Canberra, Australian Capital Territory
Australia

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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