Adjustment to Negative Price Shocks by a Commodity Exporting Economy: Does Exchange Rate Flexibility Resolve a Balance of Payments Crisis?

Nakatani, Ryota (2018): Adjustment to Negative Price Shocks by a Commodity Exporting Economy: Does Exchange Rate Flexibility Resolve a Balance of Payments Crisis?

Abstract

Negative commodity price shocks can induce balance of payments crises in resource dependent economies. Governments often react by intervening against currency depreciation as, for example, in the case of Papua New Guinea in response to the commodity price shocks of 2014. We develop an original theoretical model to analyze the balance of payments impact of a commodity price shock under alternative exchange rate regimes: a flexible rate regime and a fixed rate regime with foreign exchange rationing. The balance of payments consequences are shown to depend on the elasticity of exports and imports with respect to the exchange rate. For the Papua New Guinea case, we estimate export elasticities for a variety of commodities (gold, silver, copper, oil, coffee, cocoa, copra, copra oil, palm oil, rubber, tea, logs, and marine products) as well as for imports. The results indicate that the Marshall-Lerner condition is satisfied for this resource-rich economy, implying that exchange rate flexibility may be practicable. We implement our calibrated model to conduct a counter-factual simulation and find that with a flexible exchange rate, foreign reserves would have been 20 percent higher three years after the shock than they were under the actual policy of exchange rate stabilization. In light of this, we argue the merits of greater exchange rate flexibility.

• Item Type: MPRA Paper
• Language: English
• Keywords: Commodity Exporters; Foreign Exchange Rationing; Papua New Guinea; Marshall-Lerner Condition; Agriculture; Mining
• Subjects: F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O13 - Agriculture ; Natural Resources ; Energy ; Environment ; Other Primary Products; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q1 - Agriculture > Q17 - Agriculture in International Trade; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q3 - Nonrenewable Resources and Conservation > Q37 - Issues in International Trade

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