Searching for a Safe Harbor: Fiscal Policy Responses in Small Island Developing States

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Mar 2024
Over the last two decades, there has been a growing empirical literature to test whether governments fiscal policies systematically respond to changes in the level of debt-to-GDP. Most research has focused on advanced and emerging economies and has overlooked developing countries, especially small island developing states (SIDS). While Caribbean fiscal reaction functions have been estimated in the literature, this paper fills a gap by broadly including all SIDS in the analysis. We find that weak fiscal sustainability has been maintained, but mostly due to the more recent period of the analysis, and with the exclusion of the outlier of São Tomé and Principe. The magnitudes of the coefficient of the increasing primary balance in response to increasing debt-to-GDP is in line with estimates from the literature including, for example, past work on Caribbean SIDS. Two novel findings are that extreme weather events are indeed associated with deteriorations in the primary fiscal balance, and that primary balances may respond pro-cyclically to economic booms and acyclically or counter-cyclically to economic busts.