A non-energy fiscal reaction function and the reserve cushion illusion

Abstract

This study aims to examine whether fiscal policy in energy-dependent economies responds systematically to rising public debt once energy-related effects are isolated. It introduces a non-energy fiscal reaction function framework and tests for the presence of a reserve cushion illusion, whereby accumulated foreign exchange reserves weaken fiscal discipline. The analysis applies an augmented fiscal reaction function to Trinidad and Tobago using annual data from 1991 to 2024. The model focuses on the non-energy primary balance and non-energy output gap and explicitly incorporates official foreign exchange reserves. An autoregressive distributed lag approach is used to estimate both short-run and long-run relationships, allowing for mixed integration orders and small sample properties. The results show no evidence of a stabilising long-run fiscal response to rising public debt. In the short run, increases in debt are associated with fiscal deterioration rather than adjustment. Foreign exchange reserve is negatively associated with the non-energy fiscal position, consistent with a reserve cushion illusion. These findings indicate that conventional fiscal indicators may overstate fiscal sustainability in energy-dependent economies. To the best of the author’s knowledge, this study is the first to jointly integrate the non-energy primary balance, non-energy output gap and official reserves into a fiscal reaction function framework. It offers a novel approach to disentangling genuine fiscal adjustment from energy-driven buffer effects and provides new insights into debt sustainability assessment in resource-dependent economies.