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Exchange Rate Regimes and Shock Persistence: Optimal Fiscal Rules for Commodity Exporters and Some Empirical Evidence

October 31, 2019

DECRG Kuala Lumpur Seminar Series

  • Commodity-exporting economies are often characterized as having needlessly pro-cyclical fiscal policy: spending when commodity prices are high, and then cutting back when commodity prices fall. In this paper we ask (i) how procyclical is fiscal policy for commodity exporters empirically? (ii) how procyclical should it be? (iii) how this changes with features of the economy, such the exchange rate (ER) regime or the commodity being exported? Using a New Keynesian model, we show that optimal fiscal policy is actually pro-cyclical in countries with flexible ERs, because commodity price shocks are usually highly persistent, and so should be spent according to the permanent income hypothesis. In contrast, fiscal policy should be countercyclical in countries with fixed ERs to smooth the business cycle.  Empirically, we estimate the degree of pro-cyclicality as the Marginal Propensity to Spend (MPS) an extra dollar of commodity revenues, and show that the MPS is pro-cyclical overall. Consistent with theory, we show that (i) the MPS is more procyclical in countries with floating ERs than those with fixed ERs, and (ii) in countries with floating ERs the MPS increases with the persistence of the price shocks of the commodities being exported. However, in countries with fixed ERs and persistent commodity price shocks, we find that fiscal policy is more pro-cyclical than is optimal. 

    Watch and join us at Live Chat: Seminar will be live-streamed, allowing for online audience participation (only available during the seminar)

  • Arthur Mendes holds a Ph.D. in Economics from the Catholic University of Rio de Janeiro (2019) and has been a Research Consultant in the Development Research Group at the World Bank since 2016. His primary research field is macroeconomics, with specialization on fiscal and monetary policy, natural resources management, and growth.

    Steven Pennings is a research economist in the Macroeconomics and Growth Team of the Development Research Group of the World Bank (DECMG). His research covers fiscal and monetary policy, political economy, exchange rate pass-though and economic growth. He holds a Ph.D. in Economics from New York University (NYU).

DETAILS

  • WHEN: Thursday, October 31, 2019; 12:30 - 2:00PM
  • WHERE: World Bank Malaysia Office, Level 3, Sasana Kijang, No. 2, Jalan Dato’ Onn
  • RSVP: Kindly RSVP by Wednesday, October 30, 2019
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