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Fiscal Policy Adjustment To Shocks In Commodity-producing Countries

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Executive Summary

This paper investigates the optimal fiscal 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.

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