One rule doesn’t fit all: Rethinking fiscal policy for commodity-exporting developing economies

The views expressed in the Let’s Talk Development blog are solely those of the author(s).

Commodity-exporting developing countries are often criticized for having fiscal policies that may make their economies more volatile. These procyclical policies involve spending more when commodity prices and government revenues are high and cutting spending when commodity prices and government revenues are low. Conventional policy advice suggests that countries should keep their spending steady, regardless of whether commodity prices are high or low (acyclical).

However, our research, recently published in the Review of Economic Dynamics, challenges this "one-size-fits-all" approach. We find that countries often do not follow this advice, and sometimes, they may be right not to do so.

A New Measure of Fiscal Procyclicality: The Marginal Propensity to Spend (MPS)

Existing measures of procyclicality do not consider the size of the commodity sector or its relationship with non-commodity revenues. We introduce a new measure of procyclicality: the marginal propensity to spend (MPS) an additional dollar of commodity revenues. Using data from 54 commodity-exporting developing countries, we find that governments spend 25 cents of every dollar of extra commodity revenue on average (MPS=0.25), indicating moderately procyclical fiscal policies.

Heterogeneity in Real-World Fiscal Policy

We also find real world fiscal policy varies with each country’s characteristics like its exchange rate (ER) regime and the persistence of commodity price shocks:

• Fixed ER countries spend 15 cents per extra dollar of commodity revenues (MPS = 0.15), showing almost acyclical behavior.

• Flexible ER countries spend around twice as much, 30 cents per extra dollar (MPS=0.3), showing more procyclical behavior.
• Persistence of Commodity Price Shocks: In flexible ER countries, the MPS increases as commodity price shocks become more long-lasting.

Could it be that countries were tailoring fiscal policy to their characteristics, like ER regime and price-shock persistence? To find out, we developed a New Keynesian model of a small open economy commodity exporter and used it to calculate optimal fiscal policy.

The Role of Commodity Price Shock Persistence

The key fact overlooked in the conventional wisdom is the persistence of commodity price shocks. If shocks are short-lived, then the conventional wisdom seems to be correct: acyclicality is always best. However, since commodity price shocks are typically long-lasting, procyclical fiscal policy can sometimes be justified: a positive commodity price shock means that the country is expected to have higher income for many years to come. Hence, the permanent income hypothesis (PIH) suggests much of this windfall should be spent, smoothing consumption.

The Importance of the Exchange Rate Regime

However, the PIH is not the only consideration for fiscal policy; the ER regime determines if fiscal policy has a secondary role to stabilize the economy which moves spending in the opposite direction (countercyclical).

• Flexible ER countries utilize monetary policy to stabilize the economy, so the secondary role of fiscal policy is less important. In such cases, fiscal policy can focus on consumption smoothing (via the PIH), leading optimal fiscal policy to be procyclical. Moreover, fiscal policy becomes more procyclical as commodity price shocks become more persistent.
• Fixed ER countries must rely on countercyclical fiscal policy for economic stabilization, as monetary policy is constrained to maintaining the value of the currency. For example, in a commodity price boom, the central bank cannot raise interest rates to cool the economy, so the government may have to cut spending instead.

Figure 1 shows the optimal spending profile from the model in response to a persistent commodity price shock that increases commodity revenues by 1% of GDP on impact (black line).  In flexible ER economies (blue line with dots), the path of spending follows the path of commodity revenues (procyclical), with around 60c of each additional dollar of the revenues being spent (MPS=0.6). In contrast, in countries with a fixed ER (red line with crosses), spending falls in the short term, but then rebounds over time as the economy stabilizes and relative prices adjust. Over the first year as a whole, the fiscal response is close to zero (acyclical, MPS=0).
 

Figure 1: Optimal Government Spending in Response to Persistent Commodity Price Shocks

^{Source: Mendes and Pennings (2025)}

Fiscal Policy: Theory vs. Reality

Although policymakers are often criticized for excess procyclicality, we find some evidence that commodity-exporting countries may be adapting fiscal policy to their economic characteristics in the way theory predicts they should. Figure 2 plots the empirical estimates of the MPS (dashed lines with shaded 95% confidence intervals) for different types of economies and compares them to the optimal MPS from the theoretical model (solid lines with circles). In both theory and reality, countries with flexible ERs are more procyclical than those with fixed ERs. Moreover, flexible ER countries appear to become much more procyclical as shocks become more persistent.

Quantitatively, the comparison is more mixed. For fixed ER countries, theory and reality are similar; the optimal policy is within the 95% confidence intervals, and both are close to being acyclical. However, for flexible ER economies, real-world fiscal policy deviates from that suggested by theory for many countries. 

Figure 2: Model-based Versus Estimated Marginal Propensity to Spend (MPS)

^{Source: Mendes and Pennings (2025)}
 

Policy Implications: A Call for Nuanced Policy Design

Our research suggests that the common "one-rule-fits-all" approach to fiscal policy for commodity exporters may have passed its use-by-date. Instead, fiscal frameworks should be tailored to country-specific characteristics such as the country’s ER regime or the persistence of commodity price shocks they face. While acyclical policy may suit some countries — those with fixed ERs or facing short-lived shocks — for others it is less appropriate. In our view, countries with a flexible ER and facing a persistent price shock have some reason to conduct procyclical fiscal policy. However, even optimal procyclical policy involves saving a significant portion of windfalls (as the MPS is much less than 1). Naturally, real-world policymakers face additional complexities like political constraints, exhaustible reserves, international borrowing constraints, and the difficulty of estimating shock persistence. But those factors probably make it even less likely that one fiscal rule fits all.