Date Added: May 2011
The authors 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 the 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). They calibrate the model to Chile's highly volatile government revenues derived from copper, and characterize the optimal fiscal reaction. They quantify the welfare gains vis-?-vis a balanced budget rule, and the degree of adequate fiscal counter-cyclicality.