Money, real output, and deficit effects of coffee booms in Colombia

This paper develops a Vector Error Correction (VEC) model and uses the recently developed technique of ‘generalized’ impulse response analysis to test the empirical relationships in the Colombian economy between coffee revenues and a set of macro variables. We find that coffee price (revenue) shocks have exerted an important influence on money growth, inflation, and real exchange rates, and the direction of these effects are in line with some of the predictions of traditional Dutch Disease type models. The major difference between our results and the results of Dutch Disease type models arise in the effects of coffee booms on real output. We find that in the time horizon of 5 years after the boom, real output has increased in response to the effects of the coffee boom. The finding that coffee booms can result in positive long-run output effects is an important finding since it contradicts the traditional conclusion of Dutch Disease type models which envision an adverse long-run effect on output. We also find that the long-run effect of coffee booms is to reduce both current account and government deficits. These results illustrate strikingly that the term “Dutch Disease” is an unfortunately pejorative term that obscures the fact that coffee booms need not be viewed as a “disease” but as an extraordinary opportunity to strengthen internal and external balances.