Policy Towards Commodity Shocks in Developing CountriesWP/96/84-EA Policy Towards Commodity Shocks in Developing Countries by Paul Collier and Jan Willem Gunning Twenty years ago the policy advice of the international financial institutions on commodity shocks was that governments should use stabilizing taxation. On the basis of a comparative study of 23 shock episodes, this paper argues that governments usually have proved to be rather bad at coping with revenue volatility. By contrast, private agents respond much more appropriately than governments in their custodial role have presumed. In particular, private agents have remarkably high saving rates from windfall income. While the case for custodial fiscal policy is weak, there is an important role for active monetary policy if the windfall is left with the private sector. During windfalls the private demand for real money balances first rises and then falls, reflecting predictable portfolio changes in response to transient income. Public policy should focus on accommodating private sector responses rather than confiscating the windfall. Despite generally high public and private savings from windfalls, this has not translated into sustained increases in output. The paper considers whether it would be better to reverse the custodial argument and transfer public shocks to the private sector. It concludes that the difficulties of such transfers make them only partially appropriate. |