Monetary and fiscal policy interactions in resource-rich emerging economies

ABSTRACT

This paper investigates monetary-fiscal interactions in resource-rich emerging economies using an estimated Dynamic Stochastic General Equilibrium model. We find evidence of an active monetary and passive fiscal policy but confirm the presence of revenue substitution; a phenomenon that alters the automatic stabilizer’s role of fiscal policy. Once the response of fiscal policy to oil-related flows is muted, the revenue substitution effect is neutralized, taxes respond positively to debt, and the stagflationary impacts of negative oil price shocks are ameliorated. Our findings highlight the need for dynamic tax policies that are less sensitive to receipts from resource rent as a strategy for achieving debt sustainability and overall macroeconomic stability in resource-rich countries.

KEYWORDS:

• Policy interaction
• oil shocks
• resource-rich economies
• DSGE

JEL CLASSIFICATION:

• E31
• E52
• E62
• E63

Acknowledgments

The author is grateful to the Editor, Dr Ashima Goyal, and the anonymous referees for their very useful comments and suggestions. I would also like to thank Hylton Hollander for sharing his program with me and for insightful discussions while preparing the paper.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. The pioneering efforts at developing a theory to explain the interaction between monetary and fiscal policy were made by Sargent and Wallace (1981) and Leeper (1991).

2. According to Blanchard and Kahn (1980), a sufficient condition for the existence of saddle-path equilibrium requires that one root of the system lies inside the unit circle and one root lies outside.

3. Salti (2008) argue that a relatively higher share of resource rents in total fiscal revenue causes resource rent to corrupt institutions, thereby leading to lower economic growth.

4. The choice of the estimation sample is largely influenced by data availability for the domestic economy.

5. The estimates for the shock persistence parameters and the standard deviation of shocks are available on request.

6. Even though oil is relatively big component of the economy – accounting for about 11% of GDP during 2010–2018, output impact of an oil price shock appears rather low. We offer two explanations for this. First, the domestic fuel pricing rule implied by the subsidy regime prevents the full transmission of the effects of an oil price shock to the domestic economy. Second, under our model set up, the exchange rate provides a buffer against external shocks. Thus, following an oil price shock and the response of monetary policy, we observe an immediate exchange rate overshooting (Figure 1).

7. The posterior estimates for the relevant parameters under the two model variants are available on request.

Additional information

Notes on contributors

Babatunde Samson Omotosho

Babatunde Samson Omotosho is a Principal Economist at the Central Bank of Nigeria, Abuja. He holds a PhD in Economics from the University of Glasgow, United Kingdom. His research interest includes macroeconomics, small open resource-rich economies, monetary policy, Dynamic Stochastic General Equilibrium (DSGE) models, and central bank communication.