| Summary: | Objective. We study the effect of remittances on the size and composition of public spending. Methodology. An optimization technique is used to develop a dynamic theoretical model and a simulation analysis. Results. It is demonstrated that remittances have a positive income effect on public goods, but a negative income effect and a price effect on social transfers, which explains why public goods increase, but social transfers can increase or fall due to changes in the remittances. Recommendations. The model makes recommendations for public policy design by characterizing the optimal level of public spending. Limitations. It is desirable to extend our analysis to consider electoral incentives and thus provide different explanations of how remittances might affect public spending. Originality. To the best of our knowledge, this is the first document that develops a theory to explain the effect of remittances on the size and composition of public spending. Conclusions. Remittances have a differentiated effect on public goods and social transfers depending on the income and price effects that affect the composition of public spending.
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