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International Monetary Fund
We review the literature on Dutch disease, and document that shocks that trigger foreign exchange inflows (such as natural resource booms, surges in foreign aid, remittances, or capital inflows) appreciate the real exchange rate, generate factor reallocation, and reduce manufacturing output and net exports. We also observe that real exchange rate misalignment due to overvaluation and higher volatility of the real exchange rate lower growth. Regarding the effect of undervaluation of the exchange rate on economic growth, the evidence is mixed and inconclusive. However, there is no evidence in the literature that Dutch disease reduces overall economic growth. Policy responses should aim at adequately managing the boom and the risks associated with it.
Gianni De Nicolò

and international financial markets. The soundness measures presented here—based on “distance-to-default” (DD) models— suggest that the rapid growth of the large banking groups during the second half of the 1990s was associated with a significant increase in their overall risk profile. More recently, however, their risk-adjusted returns appear to have improved, and their soundness was further underpinned by ongoing increases in capital adequacy ratios. 1 The strong performance of the six large banking groups speaks to a high degree of resilience of the Canadian

International Monetary Fund

the same time) to large, common shocks could increase even if each bank individually was better hedged against risks. 14. This section evaluates trends in Canada’s financial system vulnerability using a market-based soundness indicator . The indicator, which was estimated for the period 1991–2003, is based on distance-to-default (DD) models commonly used in the finance literature and increasingly reported in central bank financial stability reports. DD is a composite measure computed as the sum of the return on the estimated market value of assets and the capital

Mr. Joong S Kang, Mr. Alessandro Prati, and Mr. Alessandro Rebucci

export performance deteriorates in response to a temporary aid shock, curtailing import possibilities and temporarily reducing growth. In standard DD models, growth is endogenous with learning-by-doing in the export sector generating positive externalities that enhance productivity growth in the entire economy. In these models, any appreciation of the real exchange rate resulting from an aid shock–even if it is temporary–leads to a reallocation of resources away from the tradable sectors and a permanent loss of productivity growth (see, for instance, Sachs and

Mr. Juan P Trevino

Economic and Monetary Community of Central Africa. 2 Western African Economic and Monetary Union. As a first step, we explore the presence of possible benefits from oil abundance and high international prices by comparing overall economic performance in the two groups of countries over time. We then compare the evolution of their real exchange rates and how they correlate with economic growth. Then, departing from traditional DD models, we also analyze the developments in the agricultural and external sectors and the evolution of various fiscal indicators, because

International Monetary Fund

price of oil will also have a negative effect on oil-importing manufacturing output. Some papers emphasize intertemporal differences of DD, like Bruno and Sachs (1982) , Chaterji and Price (1988), Arellano et al. (2005) , and Prati and Tressel (2005) —the later two focusing on the DD-effects of foreign aid. Bruno and Sachs (1982) build a DD model extended to allowing for short-run capital specificity and long-run capital mobility, international capital flows, and intertemporal optimization. By simulating an infinite-horizon economy, the main contribution is to

International Monetary Fund. Middle East and Central Asia Dept.

. 11 The modest size of the sample used for the regression and the low correlation coefficient call for caution when interpreting these results. 12 Contrary to the main model, in the DD model the lagged tradable inflation variable does not emerge with a statistically significant coefficient. 13 For example during ( t –1) nontradable and tradable prices increased by 22 percent and 20 percent respectively, then a 1.7 percent price increase in nontradables is carried forward to period t . 14 Assuming that a Sudan household’s average propensity to

International Monetary Fund. Monetary and Capital Markets Department

prices) are combined with accounting data in a fashion similar to the distance-to-default (DD) model for individual banks, which approximates probabilities of default in banks. Unlike the DD model, however, the expected loss also takes into account different losses given default estimates for banks in the system (reflecting their different size) and the co-movement of their share prices (to approximate the likelihood of interbank spillovers or common shocks). The figure indicates that risks among the internationally diversified banks as a group appear to be higher

Mr. Juan P Trevino
The paper employs a heuristic comparative approach suggested by Ismail (2009) to search for evidence of Dutch disease in oil-rich countries of the Central African Economic and Monetary Community (CEMAC). While these countries have benefitted from high international oil prices in recent years, they have also experienced relatively large real exchange rate appreciations, raising concerns regarding the presence of Dutch disease and casting doubts on their ability to achieve high growth and employment in the long run. To isolate from any dynamics related to the exchange rate regime, we focus on the 14 member countries that constitute the CFA franc zone. We separate them into net oil importers and net oil exporters and look at economic growth, the real exchange rate, and the agricultural and external sectors. Based on traditional models, our findings are broadly consistent with the presence of Dutch disease in the second group during the oil-price boom. Departing from these models yields mixed results, suggesting the need to employ a case-by-case approach.
Mr. Joong S Kang, Mr. Alessandro Prati, and Mr. Alessandro Rebucci
We use a heterogeneous panel VAR model identified through factor analysis to study the dynamic response of exports, imports, and per capita GDP growth to a “global” aid shock. We find that a global aid shock can affect exports, imports, and growth either positively or negatively. As a result, the relation between aid and growth is mixed, consistent with the ambiguous results in the existing literature. For most countries in the sample, when aid reduces exports and imports, it also reduces growth; and, when aid increases exports and imports, it also increases growth. This evidence is consistent with a DD hypothesis, but also shows that aid-receiving countries are not “doomed” to catch DD.