Intertemporally consistent shadow prices in an open economy: Estimates for Cyprus

In the practical estimation of shadow prices, the assumption that the economy is on a steady-state growth path is often invoked, usually implicitly. Most developing countries are far from this trajectory. We derive shadow prices where the dynamic evolution of the economy is endogenously determined, important influences being initial conditions and the constraints on foreign borrowing. Hence, the resulting (dated) shadow prices of tradeables, nontradeables, labor and the accounting rate of interest (ARI) are mutually consistent. Estimates for the Republic of Cyprus show that derivations from steady-state growth can be significant, leading to large fluctuations in the ARI and thereby making the timing of investment projects crucial.