One Rule Fits All ? Heterogeneous Fiscal Rules for Commodity Exporters When Price Shocks Can BePersistent: Theory and Evidence

Arthur Galego Mendes and Steven Michael Pennings

No 9400, Policy Research Working Paper Series from The World Bank

Abstract: Commodity-exporting developing economies are often characterized as having needlesslyprocyclical fiscal policy: spending when commodity prices are high and cutting back when prices fall. The standardpolicy advice is instead to save during price windfalls and maintain spending during price busts. This paper questionsthis characterization and policy advice. Using a New Keynesian model, it finds that optimal fiscal policy isheterogeneous depending on the commodity exported and exchange rate regime. Optimal fiscal policy is oftenprocyclical in countries with floating exchange rates because many commodity price shocks are highly persistent,and so they should be spent according to the permanent income hypothesis. In contrast, in countries with fixedexchange rates, optimal fiscal policy becomes countercyclical to smooth the business cycle. Empirically,the paper introduces a new measure of fiscal cyclicality, the marginal propensity to spend (MPS) an extra dollar ofcommodity revenues, and shows that it is moderately procyclical overall but highly heterogeneous acrosscountries depending on their characteristics. Consistent with theory, the MPS is more procyclical in countries withfloating exchange rates than those with fixed exchange rates. Moreover, in countries with floating exchange rates,the MPS is higher in countries facing more persistent commodity price shocks.

Keywords: Economic Adjustment and Lending; Public Sector Economics; Public Finance Decentralization and Poverty Reduction; Macro-Fiscal Policy; Commodity Risk Management; International Trade and Trade Rules; Macroeconomics and Economic Growth; Economic Policy; Institutions and Governance; Fiscal & Monetary Policy (search for similar items in EconPapers)
Date: 2020-09-15
New Economics Papers: this item is included in nep-dge, nep-mac and nep-opm
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