Working Paper

The long–run macroeconomic impacts of fuel subsidies

Abstract: Many developing and emerging market countries have subsidies on fuel products. Using a small open economy model with a non-traded sector I show how these subsidies impact the steady state levels of macroeconomic aggregates such as consumption, labor supply, and aggregate welfare. These subsidies can lead to crowding out of non-oil consumption, inefficient inter-sectoral allocations of labor, and other distortions in macroeconomic variables. Across steady states aggregate welfare is reduced by these subsidies. This result holds for a country with no oil production and for a net exporter of oil. The distortions in relative prices introduced by the subsidy create most of the welfare losses. How the subsidy is financed is of secondary importance. Aggregate welfare is significantly higher if the subsidies are replaced by lump-sum transfers of equal value.

Keywords: Fiscal; policy;

https://doi.org/10.24149/wp1303

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Working Papers

Publication Date: 2013

Number: 1303

Note: Published as: Plante, Michael (2014), "The Long–run Macroeconomic Impacts of Fuel Subsidies," Journal of Development Economics 107: 129-143.