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Fiscal Policy Adjustment to Shocks in Commodity-Producing Countries

  • Karlygash Kuralbayeva

This paper investigates the optimal scal policy adjustment to adverse terms of trade shocks by commodity-producing countries within a general equilibrium model,which allows for explicit distinction between public investment and government consumption. As the private sector has limited room for maneuver in correcting the shock itself, the public sector is used to isolate the economy from external fluctuations. The ability of fiscal policy to shield the economy from external shocks critically depends on instruments available to government. In the presence of international capital market imperfections, the shock is absorbed primarily through a combination of reduced expenditure and higher taxes. Cuts in expenditure are carried out mostly through cuts in public investment, with the change in the levelof public investment being about ten times larger than the change in government consumption. Public investment is thus the main shock absorber in this situation and is highly pro-cyclical. In the absence of distortions on the international capital markets, government shifts from domestic sources to external sources to absorb the shock and resorts to increased external borrowing to finance the shortfall in revenues. In this case, responses of both public investment and government consumption are more smoothed and less pro-cyclical, whereas tax rate falls.

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Paper provided by Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford in its series OxCarre Working Papers with number 060.

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Date of creation: 2011
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Handle: RePEc:oxf:oxcrwp:060
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  1. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEG Working Papers 20017, Trinity College Dublin, Department of Economics.
  2. Schmitt-Grohé, Stephanie & Uribe, Martín, 2002. "Closing Small Open Economy Models," CEPR Discussion Papers 3096, C.E.P.R. Discussion Papers.
  3. Kevin J. Lansing, 1998. "Optimal Fiscal Policy in a Business Cycle Model with Public Capital," Canadian Journal of Economics, Canadian Economics Association, vol. 31(2), pages 337-364, May.
  4. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2002. "Optimal Monetary Policy," NBER Working Papers 9402, National Bureau of Economic Research, Inc.
  5. Alberto Alesina & Silvia Ardagna, 2010. "Large Changes in Fiscal Policy: Taxes versus Spending," NBER Chapters, in: Tax Policy and the Economy, Volume 24, pages 35-68 National Bureau of Economic Research, Inc.
  6. Faia, Ester & Monacelli, Tommaso, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," CEPR Discussion Papers 5522, C.E.P.R. Discussion Papers.
  7. Kevin J. Lansing, 1994. "Optimal fiscal policy when public capital is productive: a business- cycle perspective," Working Paper 9406, Federal Reserve Bank of Cleveland.
  8. Cafiero, Carlo & Bobenrieth H., Eugenio S.A. & Bobenrieth H., Juan R.A. & Wright, Brian D., 2011. "The empirical relevance of the competitive storage model," Journal of Econometrics, Elsevier, vol. 162(1), pages 44-54, May.
  9. Talvi, Ernesto & Vegh, Carlos A., 2005. "Tax base variability and procyclical fiscal policy in developing countries," Journal of Development Economics, Elsevier, vol. 78(1), pages 156-190, October.
  10. Frederick Van der Ploeg & Anthony J. Venables, 2009. "Harnessing Windfall Revenues: Optimal Policies for Resource-Rich Developing Economies," CESifo Working Paper Series 2571, CESifo Group Munich.
  11. Larry E. Jones & Rodolfo E. Manuelli & Henry E. Siu, 2005. "Fluctuations in Convex Models of Endogenous Growth II: Business Cycle Properties," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 805-828, October.
  12. Ethan Ilzetzki & Carlos A. Vegh, 2008. "Procyclical Fiscal Policy in Developing Countries: Truth or Fiction?," NBER Working Papers 14191, National Bureau of Economic Research, Inc.
  13. Demirel, Ufuk Devrim, 2010. "Macroeconomic stabilization in developing economies: Are optimal policies procyclical?," European Economic Review, Elsevier, vol. 54(3), pages 409-428, April.
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