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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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File URL: http://eprints.lse.ac.uk/51557/
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 51557.

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Length: 30 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:ehl:lserod:51557

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Citations

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Cited by:
  1. Ricardo Reis, 2013. "The Portugese Slump and Crash and the Euro Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 46(1 (Spring), pages 143-210.
  2. Bussière, Matthieu & Lopez, Claude & Tille, Cédric, 2014. "Do Real Exchange Rate Appreciations Matter for Growth?," CEPR Discussion Papers 9938, C.E.P.R. Discussion Papers.
  3. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2013. "Capital Controls or Real Exchange Rate Policy?: A Pecuniary Externality Perspective," IDB Publications 80682, Inter-American Development Bank.
  4. Martin Berka & Michael B. Devereux, 2013. "Trends in European real exchange rates," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 28(74), pages 193-242, 04.
  5. Philip R. Lane, 2013. "Growth and Adjustment Challenge for the Euro Area," The Institute for International Integration Studies Discussion Paper Series iiisdp426, IIIS.
  6. Bussirère, Matthieu & Lopez, Claude & Tille, Cédric, 2013. "Currency Crises in Reverse: Do Large Real Exchange Rate Appreciations Matter for Growth?," MPRA Paper 44053, University Library of Munich, Germany.

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