Commodity Prices and Fiscal (Pro)Cyclicality

Authors:
  • IPIvan Petrella
    Ivan Petrella
  • LJLuciana Juvenal
    Luciana Juvenal
  • FPFederico Di Pace
    Federico Di Pace
Publisher website
Google Scholar
Abstract
Consensus holds that Emerging Markets and Developing Economies (EMDEs) engage in procyclical fiscal behavior. We emphasize that considering conditional responses to macroeconomic shocks is crucial when evaluating fiscal cyclicality, as neglecting this can result in significant biases. This study investigates the effects of exogenous commodity price shocks on fiscal variables in EMDEs by exploiting major narrative episodes and the heterogeneous exposure of countries to these shocks. Our results reveal that, following an expansionary shift in the terms of trade, fiscal authorities raise government spending and moderately increase taxes. The overall fiscal stance mitigates the effect of commodity price booms while leading to an improvement in the primary balance. These findings contrast with conventional wisdom but align with the optimal policy response to export price shocks predicted by a multi-good small open economy model with incomplete financial markets. We also highlight the role of institutional quality in shaping fiscal policy responses.