ARE WINDFALLS A CURSE - A NON-REPRESENTATIVE AGENT MODEL OF THE CURRENT ACCOUNT

A puzzling feature of temporary terms of trade booms is that some coun tries have responded to such windfalls by running current account defi cits. Furthermore, those countries that ran current account deficits f ailed to attain greater post-boom growth rates, indicating the deficit s were consumed or invested in low quality projects. The point we make is that the structure of the fiscal process is critical in determinin g outcomes. If fiscal control is unitary, then the consumption-smoothi ng effect is operative, and representative-agent models of the current account have predictive power. However, if control is divided among s everal fiscal claimants, a voracity effect appears which counteracts t he consumption smoothing effect, leading to a deterioration of the cur rent account in response to a positive temporary shock. We model the i nteraction among fiscal claimants as a dynamic game and show that in e quilibrium aggregate appropriation increases more than the windfall it self. This results in a deterioration of the current account. We also show that all the windfall is dissipated, with the country experiencin g no increase in welfare. (C) 1998 Elsevier Science B.V.