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Fiscal dominance and the financial resource curse: The Paradoxes of Plenty and Banking

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  • Constantine, Collin

Abstract

This article models banking under the condition of fiscal dominance or monetised-fiscal deficits, and explains why resource-based economies experience a financial resource curse. The evidence shows that commodity price shocks engender premature deindustrialisation, reduce loan-deposit ratios and increase interest rate spreads, among other banking pathologies. The model demonstrates that commodity booms are accompanied by monetisation shocks as these explain accelerating bank deposits, interest costs, and persistent non-borrowed and non-remunerated reserves in the banking system. In turn, these lower the bank’s profit margin (profitsdeposits), liquidity (bondsdeposits), and capital adequacy ratios (capitalloans). Therefore, the bank raises (lowers) its lending (deposit) rate to satisfy banking regulations without compromising profits. Thus, fiscal dominance reduces (raises) the loan-deposit ratio (interest rate spread). Moreover, the model shows that fiscal dominance increases the bank’s share of consumer loans as a defensive measure against rising interest costs or non-bank competition, and triggers an unstable boom in property prices.

Suggested Citation

  • Constantine, Collin, 2025. "Fiscal dominance and the financial resource curse: The Paradoxes of Plenty and Banking," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 6(2).
    • Handle: RePEc:eee:lajcba:v:6:y:2025:i:2:s2666143824000139
    DOI: 10.1016/j.latcb.2024.100131
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    Keywords

    Monetised-fiscal deficits; Banking; Financial resource curse; Fiscal dominance;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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