Commodity prices and fiscal policy design: Procyclical despite a rule

We analyse if the adoption of a fiscal rule insulates the domestic economy from
commodity price fluctuations in a resource-rich economy. To do so we develop a timevarying
Dynamic Factor Model, in which both the volatility of structural shocks and the
systematic fiscal policy responses are allowed to change over time. We focus on a
particular country, Norway, that is put forward as exemplary with its handling of resource
wealth; income from the sale of petroleum is first saved in a sovereign wealth fund for
then to be spent following a fiscal rule. We find that, contrary to common perception,
fiscal policy has been more (not less) procyclical with commodity prices since the
adoption of the rule. Fiscal policy has thereby exacerbated the commodity price
fluctuations on the domestic economy. Still, compared to many other resource-rich
economies practising a more spend-as-you-go strategy the responses are modest, as
also documented in our counterfactual analysis. From a policy point of view, the
implications of our findings are therefore of general interest since they highlight strengths
and weaknesses of fiscal rules adopted in resource rich countries.