No. 3/2012: Is it really worse with a Bird in Hand? A comparison of fiscal rules for resource-rich economies

Abstract

This paper produces a normative evaluation of fiscal rules for a resource- rich small open economy. Ad-hoc fiscal rules might be sub-optimal and imply substantial welfare costs: the target is to analyze the magnitude of the costs by evaluating the relative welfare sub-optimality of these rules. I posit a closed-form solution for the in finite horizon maximization problem of the social planner of a small open economy with resource price uncer- tainty and precautionary saving. The model is subsequently calibrated to provide a welfare-based comparison between the fiscal rule based on the Permanent Income Hypothesis and the ad-hoc Bird in Hand rule. The result of the calibration indicates the presence of a positive absolute welfare gap and of an approximately null relative wealth loss from employing the Bird in Hand rule. This result is shown to be robust under di¤erent parameterizations. No, it is not that much worse with a Bird in Hand policy.