Do Sovereign Wealth Funds Reduce Fiscal Policy Pro-cyclicality New Evidence Using a Non-Parametric Approach

DoSovereignWealthFundsReduceFiscalPolicyPro-cyclicality?NewEvidenceUsingaNon-ParametricApproach AliJ.Al-SadiqandDiegoAlejandroGutiérrez WP/23/133 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 JUL ©2023InternationalMonetaryFundWP/23/133 IMFWorkingPaper WesternHemisphereDepartment DoSovereignWealthFundsReduceFiscalPolicyPro-cyclicality?NewEvidenceUsingaNon-ParametricApproach PreparedbyAliJ.Al-SadiqandDiegoAlejandroGutiérrez* AuthorizedfordistributionbyPatriziaTumbarelloJune2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Theheightenedvolatilityofcommoditypricesinrecentyears,reflectingtheeffectsofthepandemicandthewarinUkraine,begsthelongstandingquestionoftheoptimalfiscalpolicyresponsetocommoditypriceshocks.Fiscalperformanceinmostcommodity-exportingcountriesistypicallyshapedbyshiftsincommoditypricesandeconomicactivity,oftenresultinginprocyclicalfiscalpolicy.OnewaytominimizetheprocyclicalityoffiscalpolicyistosetupastabilizationSovereignWealthFund(SWF).Whilesuchfundscanhelpsmoothgovernmentconsumptioningoodandbadtimes,theempiricalevidenceoftheirvaluesofarhasbeeninconclusive.However,usinganunbalancedpaneldatasetfor182countriesduring1980-2019,withtwoeconometricmethodsthataddresstheselection-biasproblem,weproviderobustevidencethatstabilizationSWFsdoindeedhelpsmoothgovernmentconsumptionbyreducingfiscalpolicyvolatilityassociatedwithcommoditypricefluctuations. RECOMMENDEDCITATION:Al-Sadiq,AliandDiegoAlejandroGutierrez,2023.“DoSovereignWealthFundsReduceFiscalPolicyPro-cyclicality?NewEvidenceusingaNon-ParametricApproach”,IMFWorkingpaper23/133.Washington,DC:InternationalMonetaryFund. JELClassificationNumbers: C33;E62;E63;H10;H30;O13;Q38 Keywords: SovereignWealthFunds;FiscalPolicyProcyclicality;MatchingAnalysis;Commodity-exportingCountries Authors’E-MailAddress: aalsadiq@imf.org,dgutierrez@imf.org *TheauthorswouldliketothankPatriziaTumbarello,AlinaCarare,OlusegunAyodeleAkanbi,VeroniqueSalins,OliverBasdevant,JoseLuis WORKINGPAPERS DoSovereignWealthFundsReduceFiscalPolicyPro-cyclicality?NewEvidenceUsingaNon-ParametricApproach PreparedbyAliJ.Al-SadiqandDiegoAlejandroGutiérrez Contents Glossary3 1.INTRODUCTION4 2.THEFREQUENCYANDIMPACTOFCOMMODITYPRICEVOLATILITY6 3.LITERATUREREVIEW9 4.EMPIRICALANALYSIS11 4.1TheModel11 4.1.1MeasuringDiscretionaryFiscalPolicyVolatility11 4.1.2TheEndogeneityofSWF12 4.1.3TheTreatmentEffectModel13 4.1.4PropensityScoreMatching14 4.2DataSources16 5.EMPIRICALResults16 5.1TheResultsoftheTreatmentEffectModel17 5.2TheResultsofPropensityScoreMatching19 6.CONCLUSION20 References26 FIGURES 1.CommodityPriceVariabilityandUnpredictability7 2.CommodityPricesandKeyMacroeconomicIndicators8 3.MacroeconomicVolatilityinCommodity-ExportingCountries9 4.SWFsAdoptioninthePastDecades10 TABLES 1.SovereignWealthFundsandVolatilyofFiscalPolicy:FixedEffectsModel17 2.SovereignWealthFundsandVolatilityofFiscalPolicy:AverageTreatmentEffects18 3.StabilizationSovereignWealthFundsandVolatilityofFiscalPolicy:Non-ParametricEstimations19 Glossary ATE AverageTreatmentEffect FEM FixedEffectsModel GDP GrossDomesticProduct GFC GlobalFinancialCrisis GMM GeneralizedMethodsofMoments ILS InstrumentalLeastSquares OLS Ordinary-LeastSquares PSM PropensityScoreMatching SWF SovereignWealthFund 1.INTRODUCTIONANDMAINMESSAGES Commoditypricevolatilityhasincreasedinrecentyears—especiallyforoil—followinginlargeparttheeffectsofthepandemicandthewarinUkraine.1Thisvolatilitypointstotheneedforanoptimalfiscalpolicyresponsetocommoditypriceshocks,especiallyforcommodity-exportingcountries.2 Themainpolicychallengefacedbymostofthesecountriesiscopingwithcommoditypricevolatility.Suchvolatilityistransmittedtotheeconomythroughseveralchannels,includingfiscalandexchangeratepolicy.3Moreover,highlyvolatilecommoditypricesgenerallyresultinvolatilecommodity-relatedrevenue,especiallyincountrieswheresuchrevenueconstitutesalargeshareoftotalbudgetrevenue.Thisoftentranslatesintovolatilepublicspending(IMF2015). Largeandpersistentswingsincommodity-relatedrevenuesometimesresultsinaprocyclicalfiscalstance.Fiscalpolicymakerstendtoincreasespendingduringperiodsofexpansion(whencommoditypricesarehigh)whiletheyareforcedtoreducespendingwhencommoditypricesandrevenuedecline(IlzetzkiandVegh,2008;VillafuerteandLopez-Murphy,2010;Erbil,2011). Thisprocyclicalbehaviorcomplicatesmacroeconomicmanagementandleadstoconsiderableoutputvolatilitythatunderminesoverallmacroeconomicperformance.4Indeed,severalempiricalstudiessuggestthathighergovernmentspendingvolatilityisassociatedwithlowereconomicgrowth(Al-Sadiqandothers,2021;BleaneyandGreenaway,2001;FurceriandKarras,2007;FatásandMihov,2003,2006)w