The Long-run Macroeconomic Impacts of Fuel Subsidies in an - PowerPoint PPT Presentation

Introduction Model Results Conclusions Non-traded Goods The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oil-importing Developing Country Michael Plante Federal Reserve Bank of Dallas November 6, 2012 Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Disclaimer The results presented here are my own and do not necessarily reflect the official views of the Federal Reserve Bank of Dallas nor the Federal Reserve System as a whole. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Introduction Fuel subsidies are an important policy issue for several reasons: ◮ Expensive to finance. ◮ Very difficult to remove. See del Granado et al. (2010), Baig et al. (2007), Coady et al. (2006), IEA (various). Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Introduction Not many results from a macro perspective: ◮ Bouakez et al. (2008) (optimal monetary policy) ◮ Coady et al. (2006) (distributional issues) ◮ del Granado et al. (2010) (distributional issues) Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Introduction My contributions / twists: ◮ Focus on (long-run) distortions. ◮ Incorporate general equilibrium effects from funding of subsidy. ◮ Focus on analytical results in a tractable model. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Introduction Preview of results: ◮ Subsidy increases use of oil products in economy. ◮ Subsidy increases output. ◮ But can crowd out non-oil consumption and distort labor supply decisions. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Model overview Standard features: 1. Small open economy model 2. Representative household 3. Representative firm produces traded good Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Model overview Non-standard features: 1. Currency substitution (no access to capital markets) 2. Household and firm demand for oil products 3. Economy imports oil products 4. Government funded subsidy on oil products Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Household The agent maximizes � ∞ � � C T , O h � � L T � � e − ρ s ds . + φ ( m , F ) (1) U − V 0 Real flow constraint A = W T L T + rb − C T − P s O h − T − π m . ˙ (2) Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Production Technology Q T = Q T � L T , O T � (3) . Firm maximizes Q T − W T L T − P s O T . (4) Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods The Government Government budget constraint (steady state) � ¯ P s � � O h + ¯ O T � P o − ¯ ¯ ¯ T + ¯ π ¯ m = . (5) Domestic oil price set ad hoc P s ≤ P o . (6) Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Foreign asset accumulation Flow equation F = Q T − C T − P o ( O h + O T ) . ˙ (7) Steady state equation ( ˙ F = 0) Q T = ¯ C T + ¯ P o � O h + ¯ O T � ¯ ¯ . Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Functional forms ◮ CES functions used for utility and production functions. ◮ σ c - Elasticity of substitution between C T and O h . ◮ τ - Intertemporal elasticity of substitution. ◮ µ - Frisch elasticity of labor supply. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods The Exercise 1. Evaluate equations at a long-run equilibrium (steady state). 2. Consider a (log) differential change in the subsidy, ˆ P s . P s < 0. 3. Assume domestic price lowered, i.e. ˆ 4. Solve for and, where possible, sign solutions for variables. 5. Lump sum taxation or inflation rate increased to finance spending. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods The Exercise Consider following cases: 1. Subsidy for households only 2. Subsidy for firms only 3. Subsidy for both Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Household Only From household’s first order conditions σ c � τγ oh + σ c γ ct θ ct � O h ˆ P s , ˆ = + (8) − τ + 1 1 σ c τ µ (1 − θ ot ) µ � − ( τ − σ c ) γ oh � σ c θ oh ˆ ˆ C T P s . = + (9) τ + 1 1 µ (1 − θ ot ) σ c τ µ Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Household Only Signing the solution for C T (Case 1): ◮ If ( τ − σ c ) ≤ 0 then C T falls when ˆ P s < 0. ◮ Substitution and income effects point in same direction. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Household Only Signing the solution for C T (Case 2): ◮ If ( τ − σ c ) > 0 then C T rises iff θ oh σ c τ µ > (1 − θ ot ) γ oh ( τ − σ c ) . Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Household Only Signing the solution for C T (Case 2): ◮ If ( τ − σ c ) > 0 then C T rises iff θ oh σ c τ µ > (1 − θ ot ) γ oh ( τ − σ c ) . ◮ Tradeoff: Pay taxes by consuming less and working more. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Household Only Other results: L T > 0 when ˆ P s < 0. ◮ ˆ Q T > 0 when ˆ P s < 0 ◮ ˆ Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Firms Only Firm’s first order condition W T = − α T ˆ ˆ o P s , (10) α T l Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Firms Only Firm’s first order condition W T = − α T ˆ ˆ o P s , (10) α T l Household’s first order conditions � � � α T � 1 − σ T o − θ ot P s + ˆ O h ˆ ˆ W T = (11) , τ + 1 1 µα T l (1 − θ ot ) µ C T ˆ O h . ˆ = (12) Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Firms Only Household’s first order conditions � � α T � � − σ T o − θ ot 1 P s + ˆ ˆ ˆ O h W T = . (13) τ + 1 1 µα T l (1 − θ ot ) µ Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Firms Only Household’s first order conditions � � α T � � − σ T o − θ ot 1 P s + ˆ ˆ ˆ O h W T = . (13) τ + 1 1 µα T l (1 − θ ot ) µ Coefficient negative iff θ ot − α T � � µ > σ T o . (1 − θ ot ) α T o Intuition: Taxes can be paid by working more and/or consuming less. Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Subsidy Benefits Firms Only Signing other solutions: L T > 0 when ˆ P s < 0. ◮ ˆ Q T > 0 when ˆ P s < 0. ◮ ˆ Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi

Introduction Model Results Conclusions Non-traded Goods Monetary Variables ◮ Possible to derive analytical solutions ◮ But impossible to sign with any surety Michael Plante Federal Reserve Bank of Dallas The Long-run Macroeconomic Impacts of Fuel Subsidies in an Oi