The Macroeconomics of a Financial Dutch Disease

Alberto Botta

No 89, DEM Working Papers Series from University of Pavia, Department of Economics and Management

Abstract: In this paper we describe the medium-run macroeconomic effects and long-run development consequences of a financial Dutch disease that may takes place in a small developing country with abundant natural resources. The first move of such a peculiar Dutch disease is on financial markets. An initial surge in FDI flows targeting domestic natural resources sets in motion a perverse cycle between exchange rate appreciation and mounting short-term capital flows. Such a spiral easily turns out to give rise to exchange rate volatility, foreign capital reversals, and sharp macroeconomic instability. In the long run, such acute macroeconomic instability as well as overdependence on natural resource exports all dampen the development of non-traditional tradable good sectors and curtail labor productivity dynamics. We advise the introduction of constraints to short-term capital inflows, in the form of taxes on exchange rate-based capital gains, to tame exchange rate/capital flows boom-and-bust cycles. We provide support to a developmentalist monetary policy that targets competitive nominal and real exchange rates in order to favor the process of production and export diversification. Such a policy stand can be particularly effective to counter-act the long-run negative effects of the financial Dutch disease we describe.

Keywords: Financial Dutch Disease; exchange rate volatility; macroeconomic instability; developmentalist monetary policy (search for similar items in EconPapers)
JEL-codes: F32 O14 O24 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2014-09
New Economics Papers: this item is included in nep-cba, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: The macroeconomics of a financial Dutch disease (2015)
Working Paper: The Macroeconomics of a Financial Dutch Disease (2015)
Working Paper: The macroeconomics of a financial Dutch disease (2014)
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