Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/283998 
Year of Publication: 
2024
Series/Report no.: 
Working Paper No. 2024-03
Publisher: 
Rutgers University, Department of Economics, New Brunswick, NJ
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.
Subjects: 
Sovereign default
Dutch disease
real exchange rates
JEL: 
F34
F41
H63
Document Type: 
Working Paper

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