Fiscal policy in resource rich economies

Does the adoption of a fiscal spending rule insulate a resource rich economy from oil price fluctuations? Paper by Bjørnland and Thorsrud analysing this issue is now published in Journal of Applied Econometrics

The response in value added in the public sector relative to the (non-oil) mainland economy. Positive numbers indicate the public sector responds more positively than the mainland economy to the shock. Source: Bjørnland and Thorsrud (JAE, 2019)

Our paper "Commodity prices and fiscal policy design: Procyclical despite a rule", (written jointly with Leif Anders Thorsud) in now published in Journal of Applied Econometrics.

This paper questions whether the adoption of fiscal spending rules insulates resource rich economies from oil price fluctuations. In pursuing the question we develop a timevarying Dynamic Factor Model, in which both the volatility of structural shocks and the systematic fiscal policy responses are allowed to change over time.

We focus on Norway. Unlike most oil exporters, Norway has established a sovereign wealth fund operated as a hybrid between a savings- and stabilization fund, and a fiscal rule designed specifically to shield the domestic economy from oil price fluctuations.

We find that, contrary to common perceptions, fiscal policy has been more (not less) procyclical with oil price fluctuations since the adoption of the fiscal rule. That is to say, fiscal policy has not effectively sheltered the economy from oil price shocks. However, following a global activity shock that also increases oil prices, the picture is more nuanced, with some components of public spending being countercyclical relative to GDP. We suggest that studies that find a countercyclical fiscal policy response in the recent boom, should put it down to global activity shocks and their domestic propagation, rather than the adopted fiscal framework.

Citation:

Hilde C. Bjørnland and Leif A. Thorsud: "Commodity prices and fiscal policy design: Procyclical despite a rule", Journal of Applied Econometrics, 34(2), 2019, 161-180. For previous working paper version, see here.