Chile`s Fiscal Rule as Social Insurance

Abstract

In this paper, we explore from a normative perspective the contours of an optimal spending rule for a government that has volatile revenues from an exogenous source such as a flow from a natural resource, very much like Chile. Specifically, we analyze policies for a government with a precautionary saving motive that decides how much to transfer from volatile copper revenues to impatient agents that differ in their private incomes, which in turn are volatile and correlated with fiscal revenues. Much as in reality, the government can save abroad, has limited space for borrowing against future revenue, and has access to an imperfect technology for targeting transfers (that is, a portion of transfers leaks to richer households). Households’ behavior is simple: they consume all available income. Output is exogenous in our model, that is, fiscal multipliers are zero, so any countercyclical action reflects the desire of increasing transfers at times when household consumption is low and government spending has a higher marginal utility, rather than a Keynesian mechanism. Fiscal policy is ultimately the implementation of social insurance. We analyze the welfare gains of an optimal rule vis-a-vis a balanced-budget rule whereby the government transfers all its revenues to households in each period. We also study the behavior of government assets and the extent to which government spending is countercyclical. We compare the optimal rule prescribed by our model with simpler rules, including the Chilean SBR, a rule that spends the permanent income from copper (a la Friedman), and linear rules similar to the SBR except that propensities to consume out of assets and structural revenues are chosen optimally. We also analyze the gains from having an escape clause.

  • Coauthors: Eduardo Engel and Rodrigo Valdes
  • Published: in Cespedes, L., F. and J. Gali (eds.), Fiscal Policy and Macroeconomic Performance (2013)
  • Date: 2013
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