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Chile’s Fiscal Rule as Social Insurance

  • Eduardo Engel
  • Christopher Neilson
  • Rodrigo Valdés

We explore the role of fiscal policy over the business cycle from a normative perspective, for a government with a highly volatile and exogenous revenue source. Instead of resorting to Keynesian mechanisms, in our framework fiscal policy plays a role because the government provides transfers to heterogeneous households facing volatile income, albeit with an imperfect transfer technology (a fraction of transfers leak to richer households). We calibrate the model to Chile’s highly volatile government revenues derived from copper, and characterize the optimal fiscal reaction. We quantify the welfare gains vis-à-vis a balanced budget rule, and the degree of adequate fiscal countercyclicality. We also analyze simpler rules, such as the structural balance rule in place in Chile during the last decade, more general linear rules, and linear rules with an escape clause. We find that the optimal rule leads to the same welfare gain as doubling the government’s copper revenues under a balanced budget rule. Chile’s structural balance rule achieves 18% of these gains, while a linear rule with an escape clause achieves 83% of the gains. The degrees of countercyclicality of the optimal rule and the linear rule with an escape clause are similar, and much larger than those of the structural balance rule.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 627.

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Date of creation: May 2011
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Handle: RePEc:chb:bcchwp:627
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  1. Atkeson, A. & Ogaki, M., 1991. "Wealth-Varying Intertemporal Elasticities of Substitution Evidence from Panel and Aggregate Data," RCER Working Papers 303, University of Rochester - Center for Economic Research (RCER).
  2. Alonso Segura, 2006. "Management of Oil Wealth Under the Permanent Income Hypothesis; The Case of Sao tome and Principe," IMF Working Papers 06/183, International Monetary Fund.
  3. Carroll, Christopher D, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, MIT Press, vol. 112(1), pages 1-55, February.
  4. Paul Levine & Joseph Pearlman & Nicoletta Batini, 2009. "Monetary and Fiscal Rules in an Emerging Small Open Economy," IMF Working Papers 09/22, International Monetary Fund.
  5. Attanasio, Orazio P & Browning, Martin, 1995. "Consumption over the Life Cycle and over the Business Cycle," American Economic Review, American Economic Association, vol. 85(5), pages 1118-37, December.
  6. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 305-46, April.
  7. Rodrigo O. Valdés & Eduardo Engel, 2000. "Optimal Fiscal Strategy for Oil Exporting Countries," IMF Working Papers 00/118, International Monetary Fund.
  8. Wojciech Maliszewski, 2009. "Fiscal Policy Rules for Oil-Producing Countries; A Welfare-Based Assessment," IMF Working Papers 09/126, International Monetary Fund.
  9. Gadi Barlevy, 2004. "The Cost of Business Cycles and the Benefits of Stabilization: A Survey," NBER Working Papers 10926, National Bureau of Economic Research, Inc.
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