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Sovereign risk and Dutch disease

Carlos Esquivel

Journal of Monetary Economics, 2025, vol. 149, issue C

Abstract: I study how, in the presence of default risk, the Dutch disease amplifies an inefficiency in the sectoral allocation of capital. In a sovereign default model with commodities and production of traded and non-traded goods, default incentives increase when more capital is allocated to non-traded production. Households do not internalize this, giving rise to an inefficiently large non-traded sector. Commodity windfalls amplify this inefficiency through the classic Dutch disease mechanism. I characterize state-contingent subsidies that implement the efficient allocation and compare them to a simpler subsidy rule that ameliorates the externality. Evidence from spreads, natural-resource rents, and sectoral investment data support the main findings of the model.

Keywords: Sovereign default; Dutch disease; Investment inefficiencies (search for similar items in EconPapers)
JEL-codes: F34 F41 H63 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:149:y:2025:i:c:s0304393224001168

DOI: 10.1016/j.jmoneco.2024.103663

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