Search

Abstract: We study the effects of permanent and temporary income shocks on precautionary saving and investment in a “store‐or‐sow” model of growth. High volatility of permanent shocks results in high precautionary saving in the safe asset and low investment or a “volatility trap,” namely, big savers invest relatively little. In contrast, low volatility of permanent shocks leads to low precautionary saving and high or low investment, depending on the volatility of temporary shocks. Empirical evidence shows a nonlinear relationship between investment and saving and that investment is a hump‐shaped function of the volatility of permanent shocks, as predicted by the model. [ABSTRACT FROM AUTHOR]

Summary: Policymakers in oil-exporting countries confront the question of how to allocate oil revenues among consumption, saving, and investment in the face of high income volatility. We study this allocation problem in a precautionary saving and investment model under uncertainty. Consistent with data in the 2000s, precautionary saving is sizable and the marginal propensity to consume out of permanent shocks is below one, in stark contrast to the predictions of the perfect foresight model. The optimal investment rate is high if productivity in the tradable sector is high enough. [Copyright &y& Elsevier]