Fiscal rules and terms of trade

This study evaluates the performance of fiscal rules in a small, open economy subject to terms-of-trade shocks. To this end, it uses a micro-founded model calibrated to the Peruvian economy and assesses the effects of fiscal rules on household welfare. The results show that the choice between more countercyclical or procyclical fiscal rules is linked to the degree of development of the financial system. In the presence of agents without access to financial markets, a more countercyclical rule yields better welfare outcomes, since the government assumes the role of saver for assets that these households cannot save themselves. Conversely, in an economy with agents who have unrestricted access to financial markets, a conventional fiscal rule may be more appropriate, as it encourages precautionary saving by individuals. (Audio: Department of Economic Publications)