Consumption Smoothing and Shock Persistence: Optimal Simple Fiscal Rules for Commodity Exporters

Arthur Mendes () and Steven Pennings
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Arthur Mendes: PUC-Rio

No 1171, Working Papers from Economic Research Forum

Abstract: A common criticism of balanced budget ?scal rules is that they increase the consumption volatility of ?nancially constrained households who are unable to smooth consumption. This paper evaluates the welfare consequences of simple ?scal rules in a model of a small commodity-exporting country with a share of ?nancially constrained households, where ?scal policy takes the form of transfers. A main ?nding is that balanced budget rules for commodity revenues often outperform more sophisticated ?scal rules where commodity revenues are saved in a Sovereign Wealth Fund (SWF). Because commodity price shocks are typically highly persistent, the households’ current income is close to their permanent income, making balanced budget rules close to optimal. For commodities like oil, where price shocks are highly persistent, it is optimal to spend more than two-thirds of windfall revenues in times of high prices, and in some cases even spend the entire windfall. But for commodities where price shocks are less persistent, like bananas or sugar, the optimal rule involves spending less than half of above-average commodity revenues (with the rest saved in a SWF). It is also best to respond counter-cyclically to non-resource GDP shocks, because those shocks are less persistent (and also a?ect households’ other income). The government does not have the ability to perfectly smooth constrained households’ consumption without adversely a?ecting unconstrained households.

Pages: 40 pages
Date: 2018-03-25, Revised 2008-03-25
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Citations: View citations in EconPapers (1)

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