Sectoral Shocks in a Dependent Economy : Long-Run Adjustment and Short-Run Accommodation

This paper examines the allocation and stabilization consequences of a resource boom in a small open economy. Both the intersectoral allocation of capital and the price of non-traded goods adjust sluggishly; in contrast the nominal exchange rate adjusts instantaneously to ensure that the conditions for uncovered interest parity in the presence of rational exchange-rate expectations are always met. The ability of monetary policy to stabilise the economy is examined, and it is shown that, even when intervention is justified in principle, policy errors which areise from confusing real and monetary shocks may worsen macroeconomic performance.Published in connection with a visit at the IIE