The impact of commodity price volatility on fiscal balance and the role of real interest rate

Abstract

The objective of this study is to explore the impact of commodity price volatility on the governments’ fiscal balance. Using a dynamic panel data model for 108 countries from 1993 to 2018, this study finds that governments’ fiscal balance deteriorates with commodity price volatility, especially for commodity-exporting economies. A one standard deviation increase in commodity price volatility leads to a reduction of approximately 0.04 units in the fiscal balance as a percentage of gross domestic product. Further, we examine the role of real interest rates in influencing the relationship between commodity price volatility and fiscal balance. The empirical results suggest that the negative impact of commodity price volatility on fiscal balance can be mitigated with a lower real interest rate. This implies under the sticky price assumption, an accommodative monetary policy could be effective in moderating the negative effect of commodity price volatility on fiscal balance.

Monetary Policy and Governance, Commodity Price Volatility and Tax Revenues in Sub-Saharan Africa

“…Regarding the objective of this study and following Medina (2021), Majumder, Raghavan and Vespignani (2022), and García-Albán, González-Astudillo and Vera-Avellán (2021), we modified the equation ( 1) by adding the CPV as an explanatory variable follows:…”

“…However, another axis of the empirical literature supports the idea that the link between CPV and tax revenue mobilization also depends on the economic policies adopted. Thus, Majumder, Raghavan and Vespignani (2022) investigated the relationship between the volatility of CPV and the budget balance within a sample of 108 developing countries (including SSA countries) over the period 1993–2018. Using a dynamic panel model, the study showed that CPV deteriorates the overall budget balance.…”

“…These authors argue that the heterogeneity in the level of tax revenue is explained by countries’ natural resource endowments tax evasion, and the level of the shadow economy (Thiao and Ouonogo 2021; Zídková 2014). The second and most recent strand of the literature focuses on the fiscal effects of CPV and found heterogeneous effects, depending on countries’ characteristics (Da and Diarra 2022; García-Albán, González-Astudillo and Vera-Avellán 2021; Majumder, Raghavan and Vespignani 2022). This contradiction could be due to misspecification and methodological issues.…”

“…Recall that tax revenues lost from corruption are estimated to be 0.01% of GDP in Africa (L’Initiative Afrique 2020). Moreover, monetary policy, through the central bank interest rate or credits to the economy, is one of the instruments on which monetary authorities could act to mitigate the fiscal impacts of CPV (Majumder, Raghavan and Vespignani 2022). This thesis is based on the assumption that, in the presence of high CPV, the central bank may reduce its interest rate to make lending terms more flexible.…”

Fuel subsidies to curb cost-push inflation: a case study of Pakistan to assess the impact of untargeted subsidies on fiscal space and current accounts

“…The consumption of crude oil has increased manifolds over the years and the consumption plateau may not be achieved in the next five to ten years (Geopolitical Intelligence Services 2022; Reuters 2021; International Energy Agency (IEA) 2021). Consequently, the movement of global oil prices has a notable impact on inflation (Liu et al 2022;Kpodar and Liu 2022), the exchange rate (Wang et al 2022), and the fiscal balance of the economies (Eregha et al 2022;Majumder et al 2022). According to the estimate of the World Bank, a 10% increase in oil price has the effect of increasing consumer price inflation (CPI) in the band of 0.2-0.6% and 0.8% in the wholesale price index (WPI) in South Asian Economies (World Bank 2022a).…”