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Cover IMF Working Papers
A Possible Approach to Fiscal Rules in Small Islands — Incorporating Natural Disasters and Climate Change
Ryota Nakatani
A big challenge for the economic development of small island countries is dealing with external shocks. The 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.
Keywords:
WP; expenditure rule; stabilization fund; capping expenditure growth; revenue rule; resource revenue; cash-flow constraint; revenue volatility; government activity; appropriation strategy; government deficit bias; C. expenditure rule; budget balance rule; Natural disasters; Fiscal rules; Climate change; Pacific Islands
Cover IMF Working Papers
A Possible Approach to Fiscal Rules in Small Islands - Incorporating Natural Disasters and Climate Change
Ryota Nakatani

the government deficit bias is severe (Yared 2018 ). The existing literature reports mixed results on the impact of escape clauses on fiscal stance. For example, Guerguil et al. ( 2017 ) find that escape clauses in fiscal rules do not seem to affect the cyclical stance of fiscal policy and public spending. In contrast, Combes et al. ( 2017 ) find that fiscal rules with escape clauses are harmful for stabilization in high-debt countries by making fiscal policy more procyclical. Thus, country authorities should be very careful when applying escape clauses to violate

Keywords:
WP; expenditure rule; stabilization fund