Auty, R. Gelb, A. (1986): “Oil Windfalls in a Small Parliamentary Democracy: Their Impact on Trinidad and Tobago.” World Development, 14, 1161–1175.
The NAIRU was estimated following the method of Fallon and Verry (1988). Their approach consists of regressing the unemployment rate on the change in wage inflation and a vector of structural variables, and then calculating an unemployment rate consistent with no change in inflation. In our example, the structural vector includes the terms of trade, the capital stock, real investment, the ratio of tax revenues to GDP, and a strike variable accounting for union militancy.
The observation that national savings and investment are highly correlated is pervasive and commonly referred to as the “Teldstein-Horioka Puzzle”. It is sometimes taken as evidence for an incomplete integration of international capital markets (for a discussion see e.g. Obstfeld and Rogoff, 1996). To build this observation into the following model in a simple way, we will take the extreme assumption that capital is not mobile internationally.
In this notation, which has become the standard in international macroeconomics, an increase in E means a real depreciation of the exchange rate.
This assumption is mainly made to mimic the observed close correlation of savings and investment in Trinidad (see figure 6), as explained in footnote 9. A more complete overlapping-generations model can reproduce this effect without assuming zero capital mobility (Obstfeld and Rogoff, 1996).
For a thorough description of the economic and political redistribution during the Trinidadian oil boom see Auty and Gelb (1986).
The savings rate actually declined, reinforcing the effect described above. This could be attributed to the fact that profits were hit harder than worker’s incomes, and the propensity to save out of profits is higher.