Effects of the fiscal rule and model assumptions on the response of inflation in the aftermath of a terms-of-trade shock

No wps107, Bank of Russia Working Paper Series from Bank of Russia

Abstract: Does a stabilization fiscal rule based on long-term resource prices and the formation of a sovereign wealth fund effectively reduce volatility of output, inflation, and exchange rate? Given that the previous fiscal rule in Russia has been violated since the beginning of 2022, what might the new fiscal rule look like and will it be effective? We tried to answer these questions using a dynamic stochastic general equilibrium model. A study shows that there are a number of economic parameters and types of fiscal rules under which the introduction of a mechanism for smoothing budget expenditures does not lead to a decrease in the volatility of some macroeconomic indicators. We have found that cases, when the introduction of a smoothing mechanism does not lead to a decrease in the volatility of output and the exchange rate, are rare and economically interpretable. As for the effect of the fiscal rule on inflation volatility, it turns out that it depends on many parameters such as such the design of the budget rule, the duration of price and wage contracts, and the presence of capital control. The fiscal rule, which operated until 2022 and used an external sovereign wealth fund, proved to be the most effective for stabilization purposes. In the new reality, with the impossibility of accumulating external reserves, the rule that saves additional oil and gas revenues within the country and uses the debt market to smooth budget revenues turned out to be the most effective and feasible.

Keywords: DSGE model; fiscal rule; inflation; exchange rate pass-through; business cycle; commodity prices; fiscal policy; monetary policy (search for similar items in EconPapers)
JEL-codes: D58 E47 E62 E63 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2022-12
New Economics Papers: this item is included in nep-cis, nep-dge, nep-mon and nep-opm
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