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Remittances may increase after a natural disaster in low- and middle-income countries by substituting for less developed local financial systems (Bettin and Zazzaro 2018).
The Pacific islands can be classified into three broad types. The first category comprises countries exporting commodities: PNG exports gas, oil, metals, agricultural products, logs and fish; Solomon Islands exports logs, and the main exports of Kiribati, Micronesia, Marshall Islands, Nauru, and Tuvalu are fish. The second is service exports, that is Fiji, Vanuatu, and Palau (as well as Samoa) export tourism. The third is countries reliant on remittances, namely Tonga and Samoa.
The golden rule improves welfare when the growth enhancing effect of new resources available for productive public spending exceeds the crowding-out effect of the debt burden arising from deficit on future economic growth (Minea and Villieu 2009). A golden rule exempting net public investment from the balanced-budget requirement allows for welfare gains to both current and future generations (Bom 2019).
Fiscal deficit can be financed by the central bank.
Recurrent expenditure is defined as expense (which is expenditure excluding net acquisition of non-financial assets) minus interest in the Government Finance Statistics Manual (GFSM) 2014. Put differently, recurrent expenditure is calculated as a sum of compensation of employees, use of goods and services, grants, social benefits, and other expenses.
Capital expenditure is called net acquisition of non-financial assets in GFSM 2014.
This framework can be also applied to other types of shock, namely the terms-of-trade shock.
The primary balance is assumed to converge toward a certain point in the steady state. If we include the fiscal authority’s nonlinear reaction to the debt level, the debt limit can be determined by the intersection of fiscal reaction function and the interest payment schedule, as graphically shown in Appendix.
The sustainability of debt depends on the concessional element of debt in the steady state. Concessional debt is more sustainable than commercial debt, owing to the lower interest rate.
Another approach to calibrate the debt target is by doing stochastic simulations (via e.g., VAR) to know the debt threshold over which the debt becomes unsustainable (IMF 2018c). However, due to limited availability of economic data in the Pacific island countries, this approach is not practically useful.
The magnitude of disaster shocks should be the effect on budget balance (stnt). However, it is very difficult to estimate it in the Pacific islands because of limited information. The 0.2 percent shock used here is the effect on GDP assuming that the government can offset the adverse impact on the economy in the steady state (s = 1). This is the lower bound of the impact of extreme weather events on budget balance, as Lis and Nickel (2010) find the fiscal impact ranges between 0.2 and 1.4 percent of GDP.
Halac and Yared (2014) showed that the ex-ante optimal fiscal rule is no longer sequentially optimal in the presence of persistent shocks.
See Lazzaroni and van Bergeijk (2014) for a meta-analysis of the literature on impact of disasters.
Note that the introduction of fiscal rules itself also reduces sovereign yield spreads (Afonso and Jalles 2019; Thornton and Vasilakis 2018).
Note that this oversimplifies and overestimates the impact because we are comparing to a case in which the poor-quality infrastructure is never replaced. In reality, it would eventually be replaced, so that the disaster really only brings the replacement date forward. Essentially we are treating a temporary total factor productivity shock (which could be quite long) as permanent.
When choosing the value of share (st), the government needs to consider the disaster recovery efforts made by the private sector and the local communities.
Here we focus on the overall budget balance rather than the primary balance for analytical simplicity.
The difference between primary balance and the budget balance in the steady state is just an interest expense in the steady state.
Another argument for reducing cyclicality of GDP is to use potential GDP like the European Union. However, the Pacific island countries do not have long GDP series time wise, and the presence of frequent natural disasters make it technically difficult to estimate potential GDP.
Becerra et al. (2015) did not find evidence to substantiate that donors reallocate post-disaster foreign aid between the recipient countries. However, the results by Becerra et al. (2014) may be underestimated because they used data between 1970 and 2008, although massive natural disasters occurred in the Pacific islands after this period.
In practice, fiscal space has to be created if the country has already exceeded the limit.
This paper focuses on recurrent expenditure and excludes analysis of government capital expense, which needs to be backed by good public investment management through better infrastructure governance (IMF 2018f).
In the Pacific, countries usually receive grants and loans from foreign governments or multilateral donors for reconstruction of infrastructure in the event of natural disasters. If public investment is financed by such grants, it will not affect the debt target.
See Burret and Feld (2018) for empirical analysis of unintended effects of fiscal rules by shifting or evading fiscal burden into accounts unconstrained by the rules.
There is considerable scope of boosting revenue from taxes on goods and services in resource-rich countries because there are empirical findings that higher resource revenues are associated with lower non-resource revenues by discouraging domestic tax efforts (Crivelli and Gupta 2014; Bornhorst et al. 2009).
For commodity exporters, stabilization funds can be funded from resource revenue windfalls. For example, the Organic Law on Sovereign Wealth Fund in PNG legislates that 50 percent of all mining and petroleum taxes, 60 percent of the proceeds of sale of mineral or petroleum assets, and 75 percent of all distributions from the State’s mining or petroleum projects will be deposited in the stabilization fund.
The frequency and severity of natural disasters in low-income countries and small states are expected to increase (Bettin and Zazzaro 2018).
Marto et al. (2018) show that the preemptive policy by building fiscal buffers in the contingency fund leads to lower public debt levels than the post-disaster reactive policy adopted in Vanuatu.
This combination of an expenditure rule and debt target is also supported empirically for other types of economy (e.g. see Bruck and Zwiener  for the case of European Monetary Union). Bergman et al. (2016) find that multiple fiscal rules enhance fiscal solvency.
Jalles (2018) find that escape clauses reduce counter-cyclicality of fiscal policy in developing countries.
Toth (2019) shows that fiscal rules contribute to disciplined fiscal policy after a change in government.