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Financial integration, productive development and fiscal policy space in developing countries

Alberto Botta, Gabriel Porcile, Danilo Spinola and Giuliano Yajima

No 38233, Greenwich Papers in Political Economy from University of Greenwich, Greenwich Political Economy Research Centre

Abstract: This paper offers a simple, tractable post-Keynesian model, which highlights the importance of structural change and productive development in defining the dynamics of the Real Exchange Rate (RER) and foreign debt in a small open developing economy. The argument is that in countries that keep the capital account open and rely on austerity policies to induce a notional surplus in the Balance of Payment, the RER can hardly be used as a tool aimed at smoothing the impacts of changes in international financial markets (as argued in the classical macroeconomic trilemma). In our model, capital flows and fluctuations in the RER endogenously feed back into each other and give rise to cyclical macroeconomic volatility. Fiscal austerity supposedly taming external imbalances exacerbates such instability. More diversified productive structures and stronger non-price competitiveness open more space for expansionary fiscal policies, make the economy more resilient to finance-led macroeconomic cycles, and make external debt more sustainable. Capital controls together with stronger price sensitivity of net exports can further stabilize the economy. The paper carries important policy implications, in particular for the combination of industrial and macroprudential policies in peripheral economies, whose pattern of specialization is highly dependent on a few, low-tech commodities. The adoption of industrial policies to foster non-price competitiveness and diversification is critical to sustain macroeconomic stability, both in the short and the long run.

Keywords: structural change; capital inflows; macroprudential policies (search for similar items in EconPapers)
JEL-codes: O0 (search for similar items in EconPapers)
Date: 2022-12-07
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Related works:
Journal Article: Financial integration, productive development and fiscal policy space in developing countries (2023) Downloads
Working Paper: Financial integration, productive development and fiscal policy space in developing countries (2023) Downloads
Working Paper: Financial integration, productive development and fiscal policy space in developing countries (2022) Downloads
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