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

December 10, 2020

Kuala Lumpur Research Seminar Series

  • Commodity-exporting developing economies are often characterized as having needlessly procyclical fiscal policy: spending when commodity prices are high and cutting back when prices fall. The standard policy advice is instead to save during price windfalls and maintain spending during price busts. This paper questions this characterization and policy advice. Using a New Keynesian model, it finds that optimal fiscal policy is heterogeneous depending on the commodity exported and exchange rate regime. Optimal fiscal policy is often procyclical 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 fixed exchange 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 of commodity revenues, and shows that it is moderately procyclical overall but highly heterogeneous across countries depending on their characteristics. Consistent with theory, the MPS is more procyclical in countries with floating 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.

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    Presentation Slides

  • Steven Pennings is an Economist in the World Bank's Development Research Group, Macroeconomics and Growth Team. His research interests include fiscal policy (especially fiscal transfers), economic growth, exchange rate pass-through, and monetary policy. He has worked at the Federal Reserve Board, the IMF, the Asian Development Bank, the Reserve Bank of Australia, as well as for Save the Children in Vietnam. He studied at New York University (PhD in economics).

    Arthur Mendes has been a Research Consultant in the Development Research Group at the World Bank since 2016. He holds a Ph.D. in Economics from the Catholic University of Rio de Janeiro (2019). In 2016, he was a visiting student at Columbia University. His doctorate research focused on the effects of unconventional monetary policy in the United States. As a consultant at the World Bank, he has worked extensively on fiscal and monetary policy in natural resource-rich countries.

DETAILS

  • WHEN (KUALA LUMPUR TIME): Thursday, December 10, 2020: 9:00 - 10:00am
  • WHEN (ET/WASHINGTON, D.C. TIME): Wednesday, December 9, 2020: 8:00 - 9:00pm
  • WATCH: WATCH RECORDING
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