associated with lower fiscal procyclicality. These results are also corroborated by the country case studies (Section VI), which show that SWFs and fiscal rules are most effective in meeting their goals when supported by strong institutions.

# **III. The effects of fiscal policy on output growth**

Procyclical fiscal policy amplifies the effect on output of a shock to economic activity—that is, “when it rains, it pours,” using the analogy of Kaminsky, Reinhart, and Végh (2004). Such shocks could originate from various sources—from the financial sector or from supply or demand shocks associated with external or domestic developments.<sup>14</sup> This section examines how increases in commodity prices have affected the behavior of fiscal policy and, in turn, output growth. Following Arroyo Marioli and Végh (2023), the total impact of the changes in commodity prices on output can be decomposed into two components. First, the “rains” component: in response to an increase in commodity prices, production rises in the commodity sector and other related sectors, and the associated increases in income generate further increases in private spending and output. The increases in output and spending, in turn, boost fiscal revenue, reducing the primary fiscal deficit. The second component depends on the response of fiscal policy. If the reduction in the fiscal deficit is conserved, fiscal policy will play a countercyclical role, dampening the increase in demand and activity. But if the reduction in the fiscal deficit leads the government to increase spending or lower taxes, fiscal policy will increase the effect of the shock on output. There will then be a “pours” component, with procyclical fiscal policy amplifying the business cycle.

# **III.1 Methodology**

To estimate the effect of fiscal policy on output, the analysis proceeds in four steps. First, to quantify the effects of changes in commodity prices on output, panel regressions are used to obtain the response of real GDP to changes in country-specific commodity price indexes.<sup>15</sup> Results show that a 10 percent increase in commodity export prices increases output by 0.63 to 0.85 percent in EMDE commodity exporters and 0.18 to 0.26 percent in advanced-economy commodity exporters (Table 5).<sup>16</sup> Second, panel regressions are used to estimate a fiscal policy reaction function (that is, the response of government spending to changes in commodity prices). The results show that EMDEs increase government spending when commodity export prices rise, indicating a procyclical fiscal policy (Table 6). Specifically, a 10 percent increase in commodity export prices leads to an increase in government spending of about 0.6 percent to 0.8 percent. In contrast, advanced economies respond countercyclically: a 10 percent increase in commodity export prices elicits a reduction in government spending of about 0.7 percent to 1.2 percent.

Third, an average fiscal multiplier is estimated for commodity exporters using a panel structural vector

> 14 Kaminsky, Reinhart, and Végh (2004) focused on net capital inflows, finding that such flows were associated with an increase in government expenditure in emerging markets and developing economies (EMDEs), while net capital outflows were associated with a decline in government expenditure. A variety of other drivers could lead to procyclical fiscal behavior.

> 15 Two control variables are used: overall terms of trade (which includes terms of trade for all traded goods and services, not just commodities, using data from the IMF) to control for trade effects, and the lagged dependent variable to capture underlying growth unrelated to commodity prices. The country-specific commodity export price index is an index that weights commodity prices by their relevance in a country’s exports. This index is a better measure of a commodity price shock for a particular country than global commodity price indexes that might include goods not exported by the particular country.

> 16 In Table 5, the coefficient for EMDEs (0.085) in column (1) is about 3.5 times as much as the coefficient for advanced economies (0.024) in column (4).

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