The Time-Varying Pass-Through of Oil Supply and Demand Shocks to Fiscal Cyclicality in a Resource-Rich Country: A Bayesian TVP-SVAR-SV Approach

The issue of fiscal procyclicality has always been one of the major ongoing concerns of economic decision-makers, especially for resource-rich countries. In such countries, the potential structural changes emanating from key important events (such as the global financial crisis, and the COVID-19 pandemic) may induce considerable oil price changes and business cycle fluctuations resulting in a systematic triggering of the fiscal adjustment mechanism. This paper investigates this issue by exploring the time-varying responses of government spending and business cycle to oil supply and demand shocks in Norway using quarterly data spanning the period 1990/2Q to 2021/1Q. After disentangling oil price shocks in oil supply, aggregate demand, and oil-specific demand shocks, we construct a time-varying parameter structural vector autoregression stochastic volatility (TVP-SVAR-SV) model to examine the time-varying pass-through of the three types of oil shocks to fiscal cyclicality. To the extent of our knowledge, this is the first attempt that accounts for these sources of oil price shocks in exploring fiscal cyclicality. The results highlight the increasingly stabilizing role of the fiscal guideline of 2001 in the post-global financial crisis. However, in the presence of major supply and demand shocks, like those raised by the COVID-19 pandemic, the Norwegian government should introduce additional rules targeting short-term aggregate demand-driven oil price shocks.