expenditure, revenues, and primary balance moves somewhat in line with the energy price index in the post-GFC period.<sup>15</sup>

# **4.2 Determinants of fiscal policy volatility**

In the previous section, we established that EMDEs and commodity exporters display higher fiscal policy volatility than other countries. But what are the factors that make fiscal policy in these countries more volatile? Are there specific economic characteristics, such as GDP per capita, that can explain this? Advanced economies tend to have a significant presence of services and manufacturing sectors that dwarf their commodity sectors. As a result, being an EMDE and a commodity exporter is highly correlated. At the same time, the group of EMDEs masks substantial heterogeneity in income levels across countries. Likewise, commodity exporters are also characterized by important differences in the type of commodity exported and their degree of commodity dependence. In the empirical exercises that follow, we examine the role of these heterogeneities across countries in driving fiscal policy volatility.

We focus on indicators of fiscal policy that are related to the spending side of the budget. While each of the four fiscal policy indicators contains important information about fiscal policy, primary expenditures, and government consumption are likely to provide a more accurate perspective on the volatility of fiscal policy decisions. The reason is that capturing exogenous changes in fiscal policy using a specification like the one in equation (1) is more straightforward when using expenditures than when using revenues (or the primary balance). The automatic stabilizer component of expenditures tends to be small, so changes in expenditures tend to be driven by discretionary stimulus packages or by changes that are unrelated to the business cycle, and these latter ones are the changes we capture in our measure of volatility. On the other hand, when it comes to revenues, our linear specification might not appropriately capture the potential nonlinear nature of tax elasticities. Given that we are dealing with a large sample of diverse countries, it would be impossible to incorporate more precise specifications of tax elasticities for each country. Our approach mimics that of the academic literature that typically uses government expenditures or government consumption to measure volatility in fiscal policy (see, for example, Fatás and Mihov 2013).

We start by examining the determinants of fiscal policy volatility. Table 2 displays a first set of exploratory results. We present three specifications each for primary expenditures (columns (1) to (3)) and government consumption (columns (4) to (6)) as our indicators of fiscal policy volatility. We start with the simplest possible specification in columns (1) and (4). Results show that the dummy variables for EMDEs and commodity exporters are significant and explain as much as 30 percent of the cross-country volatility in fiscal policy. That is, even after controlling for EMDEs, commodity exporters by themselves display more volatility. This suggests that commodity dependence is a source of volatility by itself. Of course, these dummy variables represent a diverse

> 15 The energy index is taken from the World Bank Commodities Prices Data. We also examined the extent to which fiscal policy volatility comoves with non-energy prices. Since the energy and non-energy indexes are highly correlated over the sample period, we chose to include only the energy index in Figure 6 for simplicity.

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