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Adjustment to Negative Price Shocks by a Commodity Exporting Economy: Does Exchange Rate Flexibility Resolve a Balance of Payments Crisis?

Ryota Nakatani

MPRA Paper from University Library of Munich, Germany

Abstract: Negative commodity price shocks can induce balance of payments crises in resource dependent economies. Governments often react by intervening against currency depreciation as, for example, in the case of Papua New Guinea in response to the commodity price shocks of 2014. We develop an original theoretical model to analyze the balance of payments impact of a commodity price shock under alternative exchange rate regimes: a flexible rate regime and a fixed rate regime with foreign exchange rationing. The balance of payments consequences are shown to depend on the elasticity of exports and imports with respect to the exchange rate. For the Papua New Guinea case, we estimate export elasticities for a variety of commodities (gold, silver, copper, oil, coffee, cocoa, copra, copra oil, palm oil, rubber, tea, logs, and marine products) as well as for imports. The results indicate that the Marshall-Lerner condition is satisfied for this resource-rich economy, implying that exchange rate flexibility may be practicable. We implement our calibrated model to conduct a counter-factual simulation and find that with a flexible exchange rate, foreign reserves would have been 20 percent higher three years after the shock than they were under the actual policy of exchange rate stabilization. In light of this, we argue the merits of greater exchange rate flexibility.

Keywords: Commodity Exporters; Foreign Exchange Rationing; Papua New Guinea; Marshall-Lerner Condition; Agriculture; Mining (search for similar items in EconPapers)
JEL-codes: F31 F32 F41 O13 Q17 Q37 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-opm
Date: 2018-06-03
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Related works:
Journal Article: Adjustment to negative price shocks by a commodity exporting economy: Does exchange rate flexibility resolve a balance of payments crisis? (2018) Downloads
Working Paper: External Adjustment in a Resource-Rich Economy: The Case of Papua New Guinea (2017) Downloads
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