Working Paper: NBER ID: w4839
Authors: Aaron Tornell; Philip Lane
Abstract: In several countries temporary terms of trade improvements have led to a deterioration of the current account. Furthermore, many of these countries failed to attain greater post-boom growth rates. The point we make is that the structure of the fiscal process is critical in determining outcomes. If fiscal control is unitary, then the consumption-smoothing effect is operative, and representative-agent models of the current account have predictive power. However, if control is divided among several fiscal claimants, a voracity effect appears which counteracts the consumption-smoothing effect, leading to a deterioration of the current account in response to a positive shock. We model the interaction among fiscal claimants as a dynamic game, and show that in equilibrium aggregate appropriation increases more than the windfall itself. This results in a deterioration of the current account. We also show that all the windfall is dissipated, with the country experiencing no increase in its growth rate. Lastly, we analyze the experiences of seven countries which have enjoyed large windfalls.
Keywords: current account; fiscal policy; terms of trade; voracity effect; dynamic game
JEL Codes: F32; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unitary fiscal control (H77) | improvement in current account (F32) |
| temporary improvement in terms of trade (F14) | improvement in current account (F32) |
| divided fiscal control (H77) | current account deterioration (F32) |
| voracity effect (D11) | current account deterioration (F32) |
| increase in aggregate appropriation by fiscal claimants (H61) | current account deterioration (F32) |
| divided fiscal authority (H77) | negative economic outcomes (F69) |