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We would like to thank Gian Maria Milesi-Ferretti for suggesting the topic and Huigang Chen for help with the numerical solution, as well as Alessandro Rebucci, Jonathan Ostry, Olivier Jeanne, Jaewoo Lee, Ran Bi, Andre Meier, Abdelhak Senhadji, Saudi Arabian authorities and participants of the IMF RES Seminar and NY Fed International Macro seminar for valuable comments and suggestions. The views expressed in the paper are those of the authors and do not necessarily represent those of the International Monetary Fund.
This modeling framework has been advocated in Davis et al (2003) and applied by numerous studies (see, e.g., de Carvalho Filho (2007) for an application to Trinidad and Tobago, Takizawa (2005) for Kuwait and Bailen, Kramarenko (2004) for Iran and Thomas et al.(2008) for a cross-country study).
In a more general model with endogenous capital, investment would provide an alternative diversification channel only when domestic return on capital exceeds the return on foreign assets. This could be the case if, for example, the economy is credit constrained or experiences a positive productivity shock. Oil revenues can then be used to exploit the temporarily higher domestic returns. However, on the balanced growth path return on domestic capital has to equal the world interest rate, limiting the long-run impact of this diversification channel.
For a discussion of productivity as a source of growth in economies with exhaustible resources and its effects on precautionary savings see section on sensitivity analysis.
From the standpoint of economic theory, this assumption can be restrictive. However, existing economic models fail to capture the observed resource extraction behavior (see, e.g., Sickles and Hartley, 2001, and Lin, 2005).
A more general utility form would be
This definition of precautionary savings differs from the one used by studies of precautionary savings in models with idiosyncratic shocks, as in e.g. Carroll (2001), where precautionary savings are usually defined as change in the distribution of savings in a stationary steady state.
To assess the effect of future income uncertainty on precautionary savings more precisely, one should consider the sum of exhaustible resource revenue shares in output, appropriately discounted. This measure needs to be further adjusted for differences between GDP and GNI as well as the increasing uncertainty associated with future price realizations.
More detailed tables with country-by-country results for each sensitivity test are available from the authors upon request.