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The Case for Restricting Fiscal Policy Discretion

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  • Fatás, Antonio
  • Mihov, Ilian

Abstract

This Paper studies how discretionary fiscal policy affects output volatility and the rate of economic growth. Using data on fifty-one countries we isolate five empirical regularities: (1) Governments that use often fiscal policy make their economies volatile; (2) The use of fiscal policy is explained to a large extent by the presence of political constraints and other political and institutional variables; (3) The volatility of output induced by discretionary fiscal policy lowers economic growth by 0.6 percentage points for every percentage point increase in volatility; (4) There is evidence that the increase in volatility is in part due to electoral cycles; nevertheless, we do find that political constraints restrain fiscal policy beyond their impact on the traditional election-year volatility; (5) Rules-based fiscal policy identified by the degree of automatic stabilizers in the economy helps to stabilize business cycles. The evidence in the Paper argues in favour of imposing institutional restrictions on governments as a way of reducing output volatility and increasing the rate of economic growth.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3277.

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Date of creation: Mar 2002
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Handle: RePEc:cpr:ceprdp:3277

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Keywords: business cycle volatility; economic growth; fiscal policy; political constraints;

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  1. Fatas, Antonio & Mihov, Ilian, 2001. "Government size and automatic stabilizers: international and intranational evidence," Journal of International Economics, Elsevier, vol. 55(1), pages 3-28, October.
  2. Ramey, Garey & Ramey, Valerie A, 1995. "Cross-Country Evidence on the Link between Volatility and Growth," American Economic Review, American Economic Association, vol. 85(5), pages 1138-51, December.
  3. Barro, R.J., 1989. "Economic Growth In A Cross Section Of Countries," RCER Working Papers 201, University of Rochester - Center for Economic Research (RCER).
  4. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-Party System as a Repeated Game," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 102(3), pages 651-78, August.
  5. Beck, T.H.L. & Clarke, G. & Groff, A. & Keefer , P. & Walsh, P., 2001. "New tools in comparative political economy: The database of political institutions," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125517, Tilburg University.
  6. Craig Burnside & Martin Eichenbaum & Jonas D.M. Fisher, 2000. "Assessing the Effects of Fiscal Shocks," NBER Working Papers 7459, National Bureau of Economic Research, Inc.
  7. Dani Rodrik, 1996. "Why Do More Open Economies Have Bigger Governments?," NBER Working Papers 5537, National Bureau of Economic Research, Inc.
  8. Boozer, Michael A., 1997. "Econometric Analysis of Panel Data Badi H. Baltagi Wiley, 1995," Econometric Theory, Cambridge University Press, vol. 13(05), pages 747-754, October.
  9. Alberto Alesina & Roberto Perotti, 1994. "The Political Economy of Budget Deficits," NBER Working Papers 4637, National Bureau of Economic Research, Inc.
  10. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(4), pages 1329-1368, November.
  11. Torsten Persson & Guido Tabellini, 2001. "Political Institutions and Policy Outcomes: What are the Stylized Facts?," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 412, Bank of Italy, Economic Research and International Relations Area.
  12. Torsten Persson, 2001. "Do Political Institutions Shape Economic Policy?," NBER Working Papers 8214, National Bureau of Economic Research, Inc.
  13. Beck, Thorsten & Clarke, George & Groff, Alberto & Keefer, Philip & Walsh, Patrick, 2000. "New tools and new tests in comparative political economy - the database of political institutions," Policy Research Working Paper Series 2283, The World Bank.
  14. Robert J. Barro & Jong-Wha Lee, 2000. "International Data on Educational Attainment: Updates and Implications," CID Working Papers, Center for International Development at Harvard University 42, Center for International Development at Harvard University.
  15. Fatás, Antonio & Mihov, Ilian, 2001. "The Effects of Fiscal Policy on Consumption and Employment: Theory and Evidence," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2760, C.E.P.R. Discussion Papers.
  16. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-party System as a Repeated Game," Scholarly Articles 4552531, Harvard University Department of Economics.
  17. repec:fth:coluec:754 is not listed on IDEAS
  18. Nouriel Roubini & Jeffrey Sachs, 1989. "Government Spending and Budget Deficits in the Industrial Economies," NBER Working Papers 2919, National Bureau of Economic Research, Inc.
  19. W. J. Henisz, 2000. "The Institutional Environment for Economic Growth," Economics and Politics, Wiley Blackwell, Wiley Blackwell, vol. 12(1), pages 1-31, 03.
  20. Barro, Robert J, 1996. " Democracy and Growth," Journal of Economic Growth, Springer, Springer, vol. 1(1), pages 1-27, March.
  21. Olivier Jean Blanchard, 1990. "Suggestions for a New Set of Fiscal Indicators," OECD Economics Department Working Papers 79, OECD Publishing.
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