autoregression (SVAR) model.<sup>17</sup> Finally, the ‘amplification’ effect (the “pours” component) of fiscal policy on output is obtained by combining the fiscal response in the second step with the fiscal multiplier obtained from the third step. The pours component represents changes in output growth that are due solely to changes in government expenditure in response to the initial shock. The “pours component” is then formally measured by: <u>g</u> P P (1) where C is the commodity export price, PP = ∆C PP∗ F PPF FF PPrrF rrFFPPrr rrF PPrrF FFrree∗ffFFPPF FF mmPPFFrrFFmmF is the estimated coefficient in the rrPP∗ yy fiscal regression and <u>g</u> is the ratio of government spending to GDP (computed as the average over the PP ffFFPPF FF PPrrF rrFFPPrr rrF PPrrF FFrree sample period for each country). Intuitively, changes in commodity export price (C ) trigger a fiscal yy reaction (elasticity), which in turn affect GDP via the fiscal multiplier. The fiscal reaction is adjusted by the size of the government to measure the final impact in percentage points of GDP.<sup>18</sup> PP

# **III.2 Impact of procyclical fiscal policy on output**

<mark>The results indicate that if an increase in the price of the exported commodity boosts output by 1.0 percentage point (the “rains” effect), procyclical fiscal policy in commodity-exporting EMDEs increases GDP by another 0.21 percentage point (the “pours” effect), boosting the total change in GDP to 1.21 percent (Figure 5.A). In contrast, fiscal policy in commodity-exporting advanced economies compensates for the cyclical effect by reacting in the opposite direction, reducing GDP by 0.65 percentage point. This leaves the net increase in GDP of 0.35 percentage point for advanced economies. These estimates suggest that, when faced with a commodity price shock of the same magnitude, the overall change in GDP can be more than three times bigger in EMDEs than in advanced economies solely because of the fiscal policy reaction.</mark> The above approach is applied to the commodity price boom of 2003–08 to illustrate the role of fiscal policy. During this period, commodity export prices increased about 76 percent for the EMDEs and 66 percent for the advanced economies in the sample. The analysis estimates the direct effect of the commodity price shock on output (the “rain” component) by applying the 2003-2008 cumulative price shock to the estimated parameters. The results indicate that the total effect on output to be 5.4 percent for EMDEs and 4.6 percent for advanced economies—that is, a difference of 0.8 percentage point (Figure 5.B). The procyclical response of fiscal policy in EMDEs (“pours” component) in another 1.1 percentage points to growth, bringing EMDE growth to 6.5 percent over this period.

In contrast, fiscal policy in advanced economies reacted in a countercyclical fashion, subtracting about 3 percentage points from growth, bringing advanced-economy growth to 1.6 percent. In other words, of the 4.9 percentage points difference between total EMDE and advanced-economy growth in the sample, 4.1 percentage points (or 84 percent) can be explained by the responses of fiscal policy—procyclical in EMDEs and countercyclical in advanced economies.

> 17 The model is based on the Blanchard and Perotti (2002) identification method, employing quarterly data for GDP and government expenditure from the IMF’s International Financial Statistics database for the period 1990-2019. In computing the “pours” component, the value of the multiplier after four quarters is used (given by 0.88).

> 18 The fiscal reaction elasticity is estimated using a panel of 15 commodity exporters (4 advanced economies and 11 EMDEs). The fiscal multiplier is estimated for the same panel following Blanchard and Perotti (2002). Government size is represented by the average government expenditure as a share of GDP for each country. The availability of quarterly data is critical for the Blanchard and Perotti (2002) identification method. This method assumes that output responds to government spending within the period, but that government spending does not respond to GDP. In other words, all contemporaneous correlation is attributed to fiscal policy affecting GDP. See Ilzetzki, Mendoza, and Végh (2013) for a detailed discussion.

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