Research Insights: How Countercyclical Should a Fiscal Rule Be in Commodity-Dependent Economies?

A fiscal rule that reacts strongly countercyclically to the domestic business cycle and mildly procyclically in response to exogenous and volatile commodity price cycles can effectively stabilize the economy, while generating significant welfare gains, especially for liquidity-constrained households. The most favorable countercyclical rule lets liquidity-constrained families accrue welfare gains of 0.6% of lifetime consumption compared to an acyclical benchmark rule. The most appropriate instrument to implement a fiscal rule is total spending: Government consumption and especially public investment help stabilize real output in bad times, while countercyclical social transfers are essential to smooth the consumption paths of financially constrained households.