Tourism as an Automatic Stabilizer

We explore how the damaging effects of a sudden stop in capital inflows to a small open economy can be dampened by an increase in spending by foreign tourists. Tourism reduces the relative importance of the traded good sector, which is especially sensitive to a rise in the cost of foreign capital. Moreover, the lower prices of non-traded goods attract more tourists whose spending slows down the price deflation and increases still more the relative importance of the non-traded good sector. This stabilizing effect increases with the price elasticity of the tourist demand function that is when the services to tourists supplied by the economy have better substitute in other countries.