RECHERCHE ET ANALYSE
Boom-Bust Cycle, Asymmetrical Fiscal Response and the Dutch Disease
Rabah Arezki: International Monetary Fund,
IMF Institute
Kareem Ismail: International Monetary Fund and Johns Hopkins
University
(uniquement en anglais)
Asymmetry in fiscal policy to resource-price shocks across different types of expenditure may have strong implications on competitiveness outside the resource sector.
Resource-rich countries often experience large
movements in their exports receipts as a result of sharp swings in
commodity prices. Governments in resource-rich countries are recipient
of income flow from natural resource, and thus play an important role in
how the resource related revenue is used and distributed. In turns,
those decisions may impact the competitiveness of those resource rich
countries. Our research investigates the behavior of expenditure policy
during boom-bust in commodity price cycles and its implication for real
effective exchange rate (REER) movements.
More specifically, our work documents and explains the limited downward
adjustment in REER during commodity price busts. This phenomenon is most
likely rooted in political pressures that governments in resource rich
countries face. Those pressures are such that it may be far easier to
increase public expenditure during commodity price booms than to cut
public expenditure during commodity price busts. In other words, bias in
the fiscal response to commodity price shocks may explain the tendency
for the level of the REER to remain elevated in commodity rich countries
following a decrease in commodity prices. For the most part,
commodity-rich countries continued to accumulate debt as public
expenditure failed to adjust sufficiently downwards following commodity
price decreases.
The implication of this asymmetry on the REER stems from the higher
import content of public capital expenditure, and thus the limited
impact of such expenditure on exchange rate appreciation relative to
current expenditure such as on wage, subsidies and services. The higher
domestic content of current expenditure spending however also means it
is more susceptible to interest group lobbying, and the wage bill and
subsidies particularly may be difficult to adjust downward due to the
adverse impact this may have on the vulnerable segment of the
population. Thus, commodity rich countries going through a commodity
price bust may rely more on cuts in capital expenditure than in current
expenditure. This results in a lesser adjustment to the real exchange
rate than would have been the case under a more symmetric pattern of
adjustment in public expenditure. In turn, this may have adverse
consequences on non-resource tradable production, which may negatively
affect the economic performance of resource rich countries over the
medium- and long-term.
Our research examines the behavior of expenditure policy during
boom-bust cycle, and its implication for REER movements. To do so, we
introduce a Dutch disease model with downward stickiness in government
current spending, which we assume is non-tradable intensive relative to
capital expenditure. In turn, this model leads to a relative decoupling
between real exchange rate and commodity price movement during busts. We
test our model's theoretical predictions and underlying assumptions
using panel data for 32 oil producing countries over the period 1992 to
2009. Results are threefold. First, we find that within-country
variation in current spending have a stronger impact on the
within-country variation in REER compared to capital spending. Second,
we find that current spending is downwardly rigid, but increase in boom
time and conversely for capital spending. Third, we find mixed results
showing that fiscal rules have helped reduce the degree of
responsiveness of current spending during booms. In contrast, we find
evidence that fiscal rules are associated with a significant reduction
in capital expenditure during busts while responsiveness to boosts is
more muted. This raises concerns about potential adverse consequences on
the long-term economic performance of oil-producing countries. Moreover,
the lack of downward adjustment in real effective exchange rate during
commodity busts may have consequences on the economic performance of
resource rich countries.
One possible recommendation for policy makers would be to limit
increases in across the board spending during boom times. That
limitation would render less difficult curbing spending during bust
times. In fact, many resource rich countries have put in place fiscal
institutions to help rein their government spending during boom times.
However, policy makers should tailor those new fiscal institutions to
account for the rigidity in current spending during busts. That will
avoid the crowding out of capital spending that is crucially needed in
many of those resource rich countries. It should be noted, however, that
the effectiveness of those fiscal institutions relies crucially on the
ability of governments in resource rich countries to design and put in
place checks and balances to prevent rent seeking and limit creative
accounting.