A fiscal vaccine against the Dutch disease

Abstract

The Dutch disease is a concern when a country is blessed with positive terms of trade (ToT) shocks. This article assesses the effects of a structural balance fiscal rule – which saves part of the revenues from better ToT – in limiting the real exchange rate (RER) appreciation. We find that the elasticity of the RER to ToT has declined (or is zero) in Chile and Norway, during the years in which the fiscal rule has been in place, although only for the part of ToT that accrue to government revenues.

Keywords:

• Real exchange rate models
• Dutch disease; dynamic OLS

JEL Classification:

• F31
• F37

Notes

¹ See Gelb (1986), Tornell and Lane (1998) and Sachs and Warner (2001) who find, in general, a real exchange rate appreciation in commodity export economies when terms of trade improve.

² See Budina et al. (2012) for the specific features of the rule in each country and Céspedes and Velasco (2014) for a review on the cyclical behaviour of fiscal policy in commodity producer countries.

³ See Phillips and Loretan (1991), Saikkonen (1991) and Stock and Watson (1993).

⁴ We check that the series are I(1) and that they cointegrate.

⁵ Results are robust to inclusion of additional leads and lags. As is noted by Choi et al. (2008), the lead and length selection issue has not been settled in the DOLS literature, hence the need of checking the robustness to alternative values of and .