From Macroeconomic Stability to Welfare: Optimizing Fiscal Rules in Commodity-Dependent Economies

I study the welfare and macroeconomic implications of simple and implementable fiscal policy rules in commodity-dependent economies, where a large share of output, exports, and government revenues depend on exogenous and volatile commodity prices. Using a multisector New Keynesian model estimated for the Chilean economy, we find that the welfare-maximizing fiscal policy involves an actively countercyclical response to the tax revenue cycle and a mildly procyclical response to the commodity revenue cycle. Compared to a benchmark acyclical policy, the optimized rule minimizes GDP growth volatility while delivering welfare gains of 0.6% of lifetime consumption to non-Ricardian (financially constrained) households. Government consumption and especially public investment are particularly helpful in stabilizing GDP, while targeted social transfers are essential to smooth the consumption of financially constrained households. Implementing the optimized rule requires moderate additional volatility (fiscal activism) in government spending and public debt.