The Investment Response to Temporary Commodity Price Shocks
The paper is concerned with the investment response to temporary trade
shocks when capital in the commodity and import-competing sectors is irreversible
once installed. Previous literature has argued in general terms that
investment is likely to rise in response to sharp relative price movements
because the return to capital in one of the sectors will increase.
A rigorous model of investment under uncertainty in the two-sector commodity
price shocks context is developed and used to investigate this issue.
It is shown that investment booms in response to commodity price shocks
are likely but not certain to occur and a boom at the end of the shock
may also be expected. The predictions of the theory are shown to
be consistent with the evidence from a small sample of countries during
the late 1970s coffee/cocoa boom.
SFS 19 March 2000