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Sovereign Risk and Dutch Disease

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  • Carlos Esquivel

    (Rutgers University)

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

Suggested Citation

  • Carlos Esquivel, 2024. "Sovereign Risk and Dutch Disease," Departmental Working Papers 202403, Rutgers University, Department of Economics.
    • Handle: RePEc:rut:rutres:202403
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    References listed on IDEAS

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    More about this item

    Keywords

    Soveriegn default; Dutch Disease; Real exchange rates;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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