Sovereign Risk and Dutch Disease

Carlos Esquivel

Departmental Working Papers from Rutgers University, Department of Economics

Abstract: I study how, in the presence of default risk, the Dutch disease amplifies an inefficiency in the sectoral allocation of capital. I develop a sovereign default model with production of tradable and non-tradable goods, and endowments of commodities. Default incentives increase when more capital is allocated to non-traded production. Households do not internalize this effect, giving rise to over-investment in the non-traded sector. Commodity windfalls amplify this inefficiency through the classic Dutch disease mechanism and an increased desire to borrow. Policies that reduce the returns of non-traded capital, such as exchange rate sterilization, ameliorate the degree of over-investment during commodity windfalls. Evidence from spreads, commodity endowments, and exchange rate data supports the main findings of the model. Select number of author(s): : 1

Keywords: Soveriegn default; Dutch Disease; Real exchange rates (search for similar items in EconPapers)
JEL-codes: F34 F41 H63 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2024-11-12
New Economics Papers: this item is included in nep-dge and nep-opm
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Journal Article: Sovereign risk and Dutch disease (2025)
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Persistent link: https://EconPapers.repec.org/RePEc:rut:rutres:202403

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