Front Matter Page
© 2019 International Monetary Fund
WP/19/186
IMF Working Paper
Asia and Pacific Department
A Possible Approach to Fiscal Rules in Small Islands — Incorporating Natural Disasters and
Climate Change
Prepared by Ryota Nakatani1
Authorized for distribution by Alison Margaret Stuart September 2019
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Abstract
A big challenge for the economic development of small island countries is dealing with external shocks. ι he Pacific Islands are vulnerable to natural disasters, climate change, commodity price changes, and uncertain donor grants. The question that arises is how should small developing countries formulate a fiscal policy to achieve economic stability and fiscal sustainability when prone to various shocks? We study how natural disasters affect long-term debt dynamics and propose fiscal policy rules that could help insulate the economy from such unexpected shocks. We propose fiscal rules to address these shocks and uncertainties using the example of Papua New Guinea. Our study finds the advantages of expenditure rules, especially a recurrent expenditure rule based on non-resource and non-grant revenue, interdependently determined by government debt and budget balance targets with expected disaster shocks. This paper contributes to the literature and policy dialogue by theoretically analyzing the impact of natural disasters on debt sustainability and proposing fiscal rules against natural disasters and climate changes. Our fiscal policy framework is practically applicable for many developing countries facing increasing frequency and impact of natural disasters and climate change. Our rules-based fiscal framework is crucial for sustainable and countercyclical macroeconomic policies to build resilience against devastating natural hazards.
JEL Classification Numbers: E32; E62; H5; H6; O23; O44; Q22; Q32; Q54; Q58
Keywords: Fiscal Rule; Expenditure Rule; Recurrent Expenditure; Natural Disaster; Climate Change; Resource Revenue; Countercyclicality; Debt Sustainability; Grants; Pacific Islands.
Author’s E-Mail Address: RNakatani@imf.org
Contents
Abstract
I. Introduction
II. Literature Review
III. Analysis of Fiscal Rules and Targets: Theory
IV. Analysis of Fiscal Rules and Targets: Practice
V. Conclusion
References
BOXES
1. Recent Episodes of Natural Disasters in the Pacific Islands
FIGURES
1. Objectives of Fiscal Policy in Pacific Islands1
2. Debt Dynamics with Natural Disaster Shocks
3. Impact of Unexpected Permanent Natural Disasters/Climate Change Shocks
4. Personnel Emoluments / Non-Resource, Non-Grant Revenue in PNG
TABLES
1. Fiscal Rules or Targets in the Pacific Island Countries
2. Volatility of GDP, Revenue, and Expenditure in the Pacific Island Countries
3. Volatile Resource Revenue Items in the Pacific Island Countries
The author thanks Scott Roger, Mareta Tauaa Kaiteie, Jacinta Tipo Hesaie, Sandile Hlatshwayo, Si Guo, Hidetaka Nishizawa, Kazuaki Miyachi, Gee Hee Hong, Yuko Kinoshita, Hiroaki Miyamoto, Masahiro Nozaki, Dongyeol Lee, Elena Loukoianova, Guohua Huang, Hideaki Matsuoka, Giovanni Ganelli, Rui Xu, Alison Margaret Stuart, Nikolay Gueorguiev, Futoshi Narita, Grant Johnston, Sali David, Laura Doherty, Paulo Medas, Carlo Pizzinelli, Julien Reynaud, Fazeer Sheik, Niklas Johan Westelius, Shinji Ayuha, Geoffrey Bannister, Hisahiro Naito, Motohiro Sato, Shinji Yamashige, Masako li, Satoshi Watanabe, participants at the Small States Seminar held at the IMF, the Program in Economic and Public Policy Special Seminar held at the University of Tsukuba, and the Public Economics Workshop held at Hitotsubashi University, officials from the Papua New Guinea Department of Treasury and the Bank of Papua New Guinea, who attended my seminar in Port Moresby, and Cook Islands authorities that I met during the technical assistance mission for very useful discussions and comments, and Medha Madhu Nair for editorial assistance.