Appendix I. Optimality Conditions
This appendix contains the first order conditions of all the optimization problems in the model. Let λt,
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We thank Yongzheng Yang for helpful comments.
For the purposes of simplicity, we classify oil, natural gas, and other oil derivatives as mineral exports.
As a rough approximation, we assume that the revenues generated by the LNG project are split between the foreign investor and the government, which receives tax revenues and dividends from the project, the last reflecting its equity stake. The foreign investor is assumed to use his revenue share to pay dividends to its foreign shareholders and to service external loans taken out to finance the project; that is, revenue flows accruing to the foreign investor are assumed to be repatriated and therefore are not available to the PNG economy. In principle, households receive income from the project in the form of wages and dividends, but these flows are small and the model we use in this paper abstracts from them for simplicity. Hence, government collection of taxes and dividends are the only inflow of LNG revenues into the PNG economy in the model used here.
See Berg et al. (2012b).
The model was simulated and solved using the Dynare package. See http://www.cepremap.cnrs.fr/dynare.
The myopic behavior of the hand-to-mouth was initially introduced to capture the excessive consumption volatility in data as in Campbell and Mankiw (1989) and to capture the demand side effects of fiscal policy as in Mankiw (2000). The hand-to-mouth households are sometimes called non-savers, liquidity-constrained or rule-of-thumb consumers.
Here we assume full expensing for investment costs when computing corporate profit taxes. In reality, firms are usually not allowed to fully expense investment costs within the period when investment is made.
The linear specification of (33) implies a 1-percent increase in public investment expenditures above the steady-state level leads to b−percent increase in effective public investment. The costs of absorptive capacity constraints in reality, however, are likely to be non-linear, depending on the level of investment. Berg et al. (2012b) specifies a convex function to capture rising absorptive capacity constraint costs along with the public investment level.
The government, of course, can also use a windfall to lower taxes or to pay down its debt. Given a large number of fiscal choices available by combining various options, we focus on relevant option of government consumption and public investment for PNG.
See also the discussion in Berg et al. (2012b), pages 15 and 19.
Only the key macroeconomic variables are shown here. The plots are annual impulse responses as measured as a percentage deviation from steady state.
It should be noted that investment is a slower process than labor migration, and hence embodies a longer-term strategy for increasing production.
This is shown in the chart through the increase in absorption, which corresponds to a widening of the current account deficit.
An alternative would have been to measure macroeconomic volatility more formally by computing the standard deviations of key variables such as real non-oil GDP or the real exchange rate, but this would have lengthened our paper without generating much additional information, given that the graphical results depict very clearly which scenarios are more volatile than others.
Both measures of the real exchange rate—the nominal CPI-deflated and the non-tradable/tradable ration—demonstrate a smaller appreciation than in the baseline scenario.
Of course, an alternative is to mitigate the macroeconomic effects of a front-loaded spending profile by aiming for a high import content of spending and raising public investment; provided the buildup of public capital is sustainable, the last will raise output permanently and thereby boost the supply response of the economy.
It should be noted that full sterilization is also set in the baseline, but since there is no reserve accumulation, there is nothing to sterilize.
This is indicated through two channels. First, the current account deficit expands by less. Second, the reduction in private sector investment reduces the long-run level of output.
This follows the bird-in-hand rule.
This creates a unit root in the accumulation process.
Throughout the paper, we use the terms “current account” and “non-oil current account” interchangeably.
See the September 2011 Monetary Policy Statement by the Bank of Papua New Guinea, page 7 paragraph 2, and Chart 5: http://www.bankpng.gov.pg/images/stories/MPS/2011/Sep_11_MPS_Final.pdf