Monetary and Economic Studies Vol.21, No.4 / December 2003

Effects of External Debt on Domestic Resource Allocation in a Small Open Economy with Limited Access to the World Capital Market

Hiroshi Fujiki, Kiyoshi Watanabe

This paper studies a small open economy with a large external debt. It begins by considering the long-term effects of shocks in the international capital market and domestic fiscal policy on the amount of outstanding external debt and the domestic reallocation of resources between the tradable and non-tradable goods sectors theoretically. Then, numerical examples on various shocks are illustrated to help understand those theoretical predictions. For example, an exogenous increase in government expenditures, together with an increase in the external borrowing rate, requires resource reallocation between the tradable goods sector and the non-tradable goods sector as well as a small amount of external borrowings to shift toward the new stationary equilibrium, whose welfare level worsens.

Keywords: External debt; Two-sector economic models

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2003 Bank of Japan All Rights Reserved.

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