A windfall of natural resource revenue (or foreign aid) faces government with choices of how to manage public debt, investment, and the distribution of funds for consumption, particularly if the windfall is both anticipated and temporary. We show that the permanent income hypothesis prescription of an ever-lasting increase in consumption financed by borrowing ahead of the windfall and then accumulating a Sovereign Wealth Fund (SWF) is not optimal for capital-scarce developing economies. Such countries should accumulate public and private capital to accelerate their development and, only if the windfall is large relative to initial foreign debt, is it optimal to build a SWF. The optimal time profile of consumption is biased towards the near future, as compared to the permanent income hypothesis. Outcomes depend on instruments available to government. We study cases where the government can make lump-sum transfers to consumers; where such transfers are impossible so optimal policy involves cutting distortionary taxation in order to raise investment and wages; and where Ricardian consumers can borrow against future revenues, in which case the policy response to possible over-consumption is a high level of investment in infrastructure.
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number
CESifo Working Paper No. 2571.
Find related papers by JEL classification: E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General F34 - International Economics - - International Finance - - - International Lending and Debt Problems F35 - International Economics - - International Finance - - - Foreign Aid F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development Q33 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Resource Booms (Dutch Disease)
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Aaron Tornell & Philip R. Lane, 1999.
"The Voracity Effect,"
American Economic Review,
American Economic Association, vol. 89(1), pages 22-46, March.
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