## Ramsey-Optimal Fiscal Spending and Reserve Accumulation Policies under Volatile Aid

_IMF Working Papers, August 1, 2025_

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## Bibliographic details
- Authors: Ioana Moldovan, Shu-Chun S. Yang, Luis-Felipe Zanna
- Published: August 1, 2025
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798229006798.001

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### Summary
- Examines Ramsey-optimal policies for fiscal spending and international reserve accumulation in response to volatile aid flows in Low-Income Countries (LICs).
- Develops a real Dynamic Stochastic General Equilibrium (DSGE) model of a small open economy.
- Fiscal spending components modeled: government transfers and public investment.
- Key LIC characteristics incorporated: Dutch disease (DD) externalities and financially constrained households.
- Central mechanism: precautionary saving leads to partial reserve accumulation and partial fiscal spending of aid.

### Model and Assumptions
- Real DSGE framework for a small open economy.
- Fiscal instruments: transfers (direct support to private consumption) and public investment (contributes to future income via capital accumulation).
- Features emphasized: DD externalities; financially constrained households.
- Objective: Ramsey-optimal allocation considering volatility of aid.

### Major Findings
- Ramsey-optimal policies involve:
  - Partial reserve accumulation.
  - Partial fiscal spending of aid.
- Role of Dutch disease externalities:
  - Stronger DD externalities require greater reserve accumulation to stabilize future output and mitigate consumption volatility.
- Role of fiscal instruments:
  - Transfers directly support private consumption smoothing.
  - Public investment sustains future income through gradual capital accumulation and contributes to consumption smoothing.
- Role of aid volatility:
  - Higher aid volatility calls for increased public investment.
  - Public capital accumulation functions as a precautionary saving instrument in addition to its developmental role.

### Policy Implications and Recommendations
- Adopt policies that balance reserve accumulation and fiscal spending rather than fully spending or fully saving aid:
  - Use partial reserve accumulation to stabilize output under strong DD externalities.
  - Use transfers to smooth private consumption in the short run.
  - Increase public investment when aid volatility is higher to accumulate public capital as precautionary saving for future income stabilization.
- Recognize public investment’s dual role:
  - Developmental role (long-run income effects).
  - Precautionary saving role (insuring against aid volatility and smoothing consumption).

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_Source: https://www.imf.org/en/publications/wp/issues/2025/08/01/ramsey-optimal-fiscal-spending-and-reserve-accumulation-policies-under-volatile-aid-564190_