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Procyclicality or Reverse Causality?

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Author Info
Ugo Panizza
Dany Jaimovich

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Abstract

There is a large literature showing that fiscal policy is either acyclical or countercyclical in industrial countries and procyclical in developing countries. Most of this literature is based on OLS regressions that focus on the correlation between a fiscal variable (usually the budget balance or expenditure growth) and either GDP growth or some measure of the output gap. This paper argues that such a methodology does not permit the identification of the effect of the business cycle on fiscal policy and hence cannot be used to estimate policy reaction functions. The paper proposes a new instrument for GDP growth and shows that, once GDP growth is properly instrumented, procyclicality tends to disappear.

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Paper provided by Inter-American Development Bank, Research Department in its series RES Working Papers with number 4508.

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Date of creation: Mar 2007
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Handle: RePEc:idb:wpaper:4508

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Jordi GalÌ & Roberto Perotti, 2003. "Fiscal policy and monetary integration in Europe," Economic Policy, CEPR, CES, MSH, vol. 18(37), pages 533-572, October. [Downloadable!] (restricted)
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  2. Paolo Manasse, 2006. "Procyclical Fiscal Policy: Shocks, Rules, and Institutions - A View From MARS," IMF Working Papers 06/27, International Monetary Fund. [Downloadable!]
  3. Zvi Hercowitz & Michel Strawczynski, 2004. "Cyclical Ratcheting in Government Spending: Evidence from the OECD," The Review of Economics and Statistics, MIT Press, vol. 86(1), pages 353-361, 01. [Downloadable!] (restricted)
  4. James H. Stock & Motohiro Yogo, 2002. "Testing for Weak Instruments in Linear IV Regression," NBER Technical Working Papers 0284, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Fabrizio Balassone & Maura Francese, 2004. "Cyclical asymmetry in fiscal policy, debt accumulation and the Treaty of Maastricht," Temi di discussione (Economic working papers) 531, Bank of Italy, Economic Research Department. [Downloadable!]
  6. Douglas Staiger & James H. Stock, 1997. "Instrumental Variables Regression with Weak Instruments," Econometrica, Econometric Society, vol. 65(3), pages 557-586, May.
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  7. Mark Aguiar & Gita Gopinath, 2004. "Emerging market business cycles: the cycle is the trend," Working Papers 04-4, Federal Reserve Bank of Boston. [Downloadable!]
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  8. Talvi, Ernesto & Vegh, Carlos A., 2005. "Tax base variability and procyclical fiscal policy in developing countries," Journal of Development Economics, Elsevier, vol. 78(1), pages 156-190, October. [Downloadable!] (restricted)
  9. Ricardo J. Caballero & Arvind Krishnamurthy, 2004. "Fiscal Policy and Financial Depth," NBER Working Papers 10532, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, 09. [Downloadable!] (restricted)
  11. Enrique Alberola & José M. Montero, 2006. "Debt sustainability and procyclical fical policies in Latin America," Banco de España Working Papers 0611, Banco de España. [Downloadable!]
  12. Bernardin Akitoby & Benedict J. Clements & Sanjeev Gupta & Gabriela Inchauste, 2004. "The Cyclical and Long-Term Behavior of Government Expenditures in Developing Countries," IMF Working Papers 04/202, International Monetary Fund. [Downloadable!]
  13. César Calderón & Roberto Duncan & Klaus Schmidt-Hebbel, 2004. "Institutions and Cyclical Properties of Macroeconomic Policies," Working Papers Central Bank of Chile 285, Central Bank of Chile. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Juliana Dutra Araujo, 2009. "Fiscal Cycles in the Caribbean," IMF Working Papers 09/158, International Monetary Fund. [Downloadable!]
  2. Alberto Alesina & Filipe R. Campante & Guido Tabellini, 2008. "Why is Fiscal Policy Often Procyclical?," Journal of the European Economic Association, MIT Press, vol. 6(5), pages 1006-1036, 09. [Downloadable!] (restricted)
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  3. Ethan Ilzetzki & Carlos A. Vegh, 2008. "Procyclical Fiscal Policy in Developing Countries: Truth or Fiction?," NBER Working Papers 14191, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. repec:bep:maccon:v:6:y:2006:i:1:p:1450-1450 is not listed on IDEAS
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  5. Laura dos Reis & Paolo Manasse & Ugo Panizza, 2007. "Targeting the Structural Balance," RES Working Papers 4507, Inter-American Development Bank, Research Department. [Downloadable!]
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