IMF endorses saving

As you may be aware, this morning the IMF rode to the support of the Australian government’s surplus drive (if resistance hasn’t already been killed by S&P). Here’s a summary of what it said:

Saving up during good times for use in bad times—via countercyclical budgetary policies—protects small commodity-exporting countries from swings in commodity prices.

But if and when the higher prices appear to be permanent, commodity exporters can begin to spend on public investment and to lower taxes to boost private sector productivity, output and welfare.

This is the conclusion of a new study by the IMF—“Commodity Price Swings and Commodity Exporters,” Chapter 4 of the April 2012 World Economic Outlook—that looks at how countries can manage the boom-bust cycle in commodity prices.

Vulnerable to swings

Commodity exporters are vulnerable to swings in prices of commodities. Their macroeconomic performance has historically fluctuated with commodity prices—improving during upswings and deteriorating during downswings. A sudden drop in global activity reduces commodity prices and commodity exporters’ GDP and external balances.

The remarkable runup of commodity prices over the past decade has helped commodity exporters remain resilient to the recent weakness in the global economy. But given the fragile global economy, there is a strong risk of prices plateauing or even dropping, with potentially serious consequences for exporters.

The IMF study looks at the macroeconomic performance of commodity exporters during commodity price cycles. It finds that when it is the global economy that is driving commodity prices, the economic effects on commodity exporters are strong.

In the current global economic situation—near record–high commodity prices combined with unusual uncertainty in the global outlook—the priority should be on upgrading policy frameworks and building fiscal buffers. Exporters should save fiscal windfalls during commodity price upswings, and spend during downswings to stabilize the domestic economy.

But if the high price levels—and thus revenues—persist, exporters should proceed cautiously, maintaining their fiscal buffers but gradually adjusting to potentially permanently higher prices by upping public investment and lowering taxes, to boost output and welfare over the long term.

If prices dropped suddenly

Exporters’ economic performance—as measured by their real GDP and credit growth, external and fiscal balances, and financial system stability—is closely tied to commodity price swings, according to the study, strengthening in upswings and weakening in downswings.

A typical downswing in energy and metal prices lasts 2–3 years, with a real price decline of 40 to 50 percent from peak to trough. This can translate into a real GDP growth reduction of ½ to 1 percentage point in the downswing relative to the upswing. And the difference in economic performance across commodity price swings is larger when price cycles are sharper or last longer than usual.

The research also looks at what would happen to commodity exporters if there were a sudden drop in commodity prices driven by deteriorating global economic conditions. It finds that commodity price changes driven by global activity have significant effects on exporters’ economic performance.

The effects are most striking for crude oil exporters. An annual global activity shock that increases the real price of oil by about 12 percent raises the real GDP of oil exporters by 0.4 percent on impact and by close to 2 percent three years afterward.

Save during good times

In general, the optimal fiscal response to temporary commodity price swings is a countercyclical one: save commodity-related revenue increases during upswings, and use these buffers during downswings to shield the economy from the volatility arising from commodity price fluctuations. Such a policy stance is most effective when a country has low public debt and when monetary policy operates under an inflation-targeting regime with a flexible exchange rate, which helps to reduce inflation volatility.

But if production shocks that affect commodity prices cannot be offset, it might be necessary, from a multilateral stability perspective, for major commodity exporters to adopt a less countercyclical fiscal response to counteract the effects of the shocks on global activity.

Permanent good luck

If commodity price changes are known to be lasting or permanent, the key question is how best to adjust to permanently higher or lower fiscal revenues. For a price increase, raising public investment and reducing labor and capital taxes boost private sector productivity, output, and welfare. Of course, in practice it is difficult to accurately identify whether commodity price changes will be temporary or permanent. So countries need to enhance policy frameworks and build fiscal buffers to address any cyclical swings in commodity prices, while also gradually incorporating new information on the persistence of commodity prices.

All sensible enough. Only one problem. The IMF offers no advice to an economy with a large commodity dependency and an equally large private sector debt overhang from previous counter-cyclical episodes.

Full report below.



  1. This bit does seem quite important.

    In general, the optimal fiscal response to temporary commodity price swings is a countercyclical one: save commodity-related revenue increases during upswings, and use these buffers during downswings to shield the economy from the volatility arising from commodity price fluctuations.

    • Mining Tax, anyone?

      I know it’s not exactly the same thing, but the basic idea is there. Commodities are booming, the rest of the country is stuffed. Funnel mining revenue to other areas of the economy to balance everything out.

      “Save commodity-related revenue increases in upswings, and use these buffers during downswings…”
      How can this be done without being labelled a [great big new] tax? Can we call it a [near] Future Fund?

  2. I know the IMF has a lot of smart people, but it’s something they should have been saying a long time ago. It might be a bit late. Agree with your comment on the large private sector debt and as a percentage of GDP we’re right up there.