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Riding the barrel: How commodity exporters can maneuver through price rapids

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Fiscal Rules for Commodity Dependent Countries Under Uncertainty. Master project by Martin Aragoneses, Mario Giarda, and Nikolas Schöll. Barcelona GSE Master's in Economics

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Riding the barrel: How commodity exporters can maneuver through price rapids

  1. 1. Riding the barrel: How commodity exporters can maneuver through price rapids Fiscal Rules for Commodity Dependent Countries Under Uncertainty Martin Aragoneses Mario Giarda Nikolas Schöll Barcelona Graduate School of Economics June 5, 2015 Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 1 / 15
  2. 2. Introduction Motivation: In summer 2014 resource prices fell drastically marking a temporary end to the high price regime. Resource dependent countries (Dutch Disease) face problems with how to deal with new uncertainty . Fiscal rules can help to smooth government expenditure and stabilize the economy. Approach: Small open-economy DSGE model to analyze level and uncertainty shocks to commodity prices. Implementation of several fiscal rules to compare performance. Application of the model to Angola and Chile focusing on differences in their commodity price processes. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 2 / 15
  3. 3. The Role of International Uncertainty Shocks 1985 1990 1995 2000 2005 2010 2015 50 100 150 200 250 Copper Oil Uncertainty matters (Bloom, 2009), also for small open economies (Fernandez-Villaverde et al, 2011) subject to global market sentiment. We explore the effects of higher exogenous commodity price uncertainty for commodity-dependent countries like Angola (oil) and Chile (copper). 2008 financial crisis/Last Summer => Uncertainty shock => drop in government revenues & precautionary behavior. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 3 / 15
  4. 4. Stochastic Volatility Model for Oil and Copper Level Shocks pCO∗ t = (1 − ρpCO∗ )pCO∗ + ρpCO∗ pCO∗ t−1 + exp(σpco t )εpCO∗ t (1) Volatility/Uncertainty Shocks (Fernandez-Villaverde et al, 2011) σpco t = (1 − ρpco )¯σpco + ρpco σpco t−1 + εpco t (2) Estimate σt pco = ln(var(εpCO∗ t ))/2 using OLS residuals in the level equation. Table: Parameters for Volatility of Copper Prices (Chile) ρpCO∗ : 0.96 (s.e. 0.03) ρpco : 0.84 (s.e. 0.04) Table: Parameters for Volatility of Oil Prices (Angola) ρpCO∗ : 0.95 (s.e. 0.03) ρpco : 0.76 (s.e. 0.05) Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 4 / 15
  5. 5. Model Open economy DSGE. We follow Richmond et al. (2013). An application for Angola. Three sector economy: commodity sector, a tradable sector and a non-tradable sector. Two frictions: limited labor mobility between tradable and non-tradable and adjustment costs in capital. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 5 / 15
  6. 6. Model: Government It is a “two entity institution”: Government: stTRt = pg t Gt + Zt + (Rt−1 − 1)B. (3) Fund: F∗ t+1 − F∗ t = 1 st (TCO t + τc ct + τl wtlt) + r∗ t F∗ t − TRt, (4) Fiscal rule: Θ : X → , (5) Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 6 / 15
  7. 7. Model Solution: 3rd order approximation. We use the calibration from IMF’s Angola model. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 7 / 15
  8. 8. Fiscal Rules: The special case of commodity exporters Fiscal rules have several important aspects: Effectively restricting government. Avoiding procyclicality. Granting sufficient flexibility to react to shocks. Being simple and transparent to be efficiently implemented and monitored by the voter. Fiscal rules have focused on restraining debt. Special case for commodity dependent country how to allocate non-renewable rent. Focus on rules smoothing the economy in the short and medium term. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 8 / 15
  9. 9. Fiscal Rules: Examples used in the the Paper Balanced budget (benchmark) The fund does not step into action. Rule 1: Fund based Government spends part of its savings (fund) and its (tax) income. Rule 2: Fixed rule Government expenditure is fixed. Rule 3: Countercyclical rule Government targets to smooth output. Rule 4: Countercyclical rule 2 Government targets to smooth consumption. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 9 / 15
  10. 10. Results: Preliminaries 5 10 15 20 25 30 −0.05 −0.04 −0.03 −0.02 −0.01 0 0.01 0.02 Y YN Y T C iN i T l N l T 5 10 15 20 25 30 −0.5 0 0.5 1 1.5 2 2.5 x 10 −5 Y YN Y T C i N i T l N l T Figure: IRF to a 1 std of the commodity prices level (left) and to variance of commodity prices (right). Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 10 / 15
  11. 11. Results: Rules comparison, level shock 0 5 10 15 20 0 2 4 6 x 10 −3 C 0 5 10 15 20 −0.03 −0.02 −0.01 0 Y T 0 5 10 15 20 −0.01 −0.005 0 0.005 0.01 0.015 Y N 0 5 10 15 20 −0.02 0 0.02 0.04 0.06 0.08 G 0 5 10 15 20 −0.1 −0.05 0 0.05 0.1 s 0 5 10 15 20 0 0.02 0.04 Transfer 0 5 10 15 20 −8 −6 −4 −2 0 x 10 −3 iT 0 5 10 15 20 0 2 4 6 8 10 x 10 −3 in 0 5 10 15 20 −0.02 0 0.02 0.04 0.06 w Figure: IRF to a 1 std commodity price level shock. Black: Budget balance. Green: Fund based. Blue: Fixed spending. Red: Countercyclical wrt. product. Gray: Countercyclical wrt consumption. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 11 / 15
  12. 12. Results: Rules comparison, variance shock 0 5 10 15 20 0 1 2 3 x 10 −5 C 0 5 10 15 20 −4 −2 0 2 4 x 10 −5 Y T 0 5 10 15 20 0 1 2 x 10 −5 Y N 0 5 10 15 20 −10 −5 0 x 10 −5 G 0 5 10 15 20 0 1 2 3 x 10 −4 s 0 5 10 15 20 −10 −5 0 x 10 −5 Transfer 0 5 10 15 20 −4 −2 0 2 4 6 x 10 −6 iT 0 5 10 15 20 0 1 2 3 x 10 −5 in 0 5 10 15 20 0 2 4 6 x 10 −5 w Figure: IRF to a 1 std commodity price level shock. Black: Budget balance. Green: Fund based. Blue: Fixed spending. Red: Countercyclical wrt. product. Gray: Countercyclical wrt consumption. Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 12 / 15
  13. 13. Application: Uncertainty Shocks for Angola and Chile Uncertainty shocks are more persistent for copper than for oil. Chile would suffer more than Angola when its economy is hit by an uncertainty shock and it takes longer to recover (precautionary response) Figure: Angola vs Chile: Uncertainty Shock under benchmark rule Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 13 / 15
  14. 14. Application: Fiscal Rules for Angola and Chile Works better for Chile for smoothing fluctuations. Figure: Angola vs Chile: Uncertainty Shock under countercyclical rule Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 14 / 15
  15. 15. Concluding Thoughts Beyond level shocks, uncertainty shocks also matter for commodity-dependent exporters Fiscal rules can be used to smooth out the effects of these shocks, but... ... we need to be careful with their design (avoiding one-size fits all). Taking into account country-specific features is key! We focus on differences in commodity price characteristics, but what about institutions? Going forward: how does diversification and investment environments relate with price shocks? Aragoneses, Giarda and Schöll (BGSE) Fiscal Rules for Commodity Dependent Countries June 5, 2015 15 / 15

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