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The Financial Resource Curse

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  • Gianluca Benigno
  • Luca Fornaro

Abstract

This paper presents a model of financial resource curse, i.e. episodes of abundant access to foreign capital coupled with weak productivity growth. We study a two-sector, tradable and non-tradable, small open economy. The tradable sector is the engine of growth, and productivity growth is increasing in the amount of labor employed by firms in the tradable sector. A period of large capital inflows, triggered by a fall in the interest rate, is associated with a consumption boom. While the increase in tradable consumption is financed through foreign borrowing, the increase in non-tradable consumption requires a shift of productive resources toward the non-tradable sector at the expenses of the tradable sector. The result is stagnant productivity growth. We show that capital controls can be welfare-enhancing and can be used as a second best policy tool to mitigate the misallocation of resources during an episode of financial resource curse.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1217.

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Date of creation: May 2013
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Handle: RePEc:cep:cepdps:dp1217

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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Keywords: Capital flows; capital controls; financial resource curse; endogenous growth;

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References

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Cited by:
  1. Ricardo Reis, 2013. "The Portuguese Slump and Crash and the Euro Crisis," NBER Working Papers 19288, National Bureau of Economic Research, Inc.
  2. Philip R. Lane, 2013. "Growth And Adjustment Challenges For The Euro Area," The Economic and Social Review, Economic and Social Studies, vol. 44(2), pages 273-295.
  3. Eric Young & Alessandro Rebucci & Christopher Otrok, 2013. "Capital Controls or Real Exchange Rate Policy? A Pecuniary Externality Perspective," 2013 Meeting Papers 641, Society for Economic Dynamics.
  4. Matthieu Bussière & Claude Lopez & Cédric Tille, 2014. "Do Real Exchange Rate Appreciations Matter for Growth?," IHEID Working Papers 06-2014, Economics Section, The Graduate Institute of International Studies.
  5. Martin Berka & Michael B. Devereux, 2013. "Trends in European real exchange rates," Economic Policy, CEPR & CES & MSH, vol. 28(74), pages 193-242, 04.

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