Abstract
The existing literature does not provide a theoretical framework for conversion of remittances into investment. If a government introduces some measure for the earner abroad to save more, the earner’s cost (to the extent of his/ her share of savings in the home country) jumps to the pre-policy cost minus the additional costs causing inefficiency prior to the remittance policy affecting the quantity of savings and hence pushing the market out of equilibrium. The supply and the demand of the savings, then adjust over time to bring the new post-policy market equilibrium. The interest rate adjustment mechanism is based on the fact that when the remittance-investment policy leads the market out of equilibrium, the buyers’ and sellers’ decisions are not coordinated at the current interest rate. It is essential to take into account the efficiency losses during the adjustment process while computing the benefits of remittance-investment policy. This paper develops a dynamic model and derives an optimal remittance-investment policy minimizing the efficiency losses (output and/ or consumption of funds lost) during the dynamic adjustment process taking into account the gains from the post-policy market equilibrium subject to a policy cost constraint.
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