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Explaining The Procyclicality of Fiscal Policy in Developing Countries

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  • Håvard Halland
  • Michael Bleaney
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    Abstract

    The procyclicality of fiscal policy that is prevalent in developing countries and emerging markets is well known. Its explanation is less clear. Recently, social inequality and the combination of corruption and democracy have been suggested as alternatives to the traditional explanation of these countries’ exposure to boom-bust cycles in international credit markets. Differences in methodological approach are also partly responsible for diverging empirical results. In this paper, competing hypotheses are tested on a comprehensive set of measures of the cyclicality of fiscal policy. The evidence for corruption and democracy is stronger than for social inequality or net foreign debt, but the interpretation of this result is less obvious, since the index of corruption is closely correlated with poor credit ratings. In OECD countries, by contrast, the cyclicality of fiscal policy largely reflects the strength of automatic stabilizers.

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    Bibliographic Info

    Paper provided by University of Nottingham, CREDIT in its series Discussion Papers with number 11/09.

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    Handle: RePEc:not:notcre:11/09

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    Keywords: fiscal cyclicality; fiscal policy; business cycles; fiscal space; foreign debt; income inequality.;

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    1. 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.
    2. Paolo Manasse, 2005. "Deficit Limits, Budget Rules and Fiscal Policy," IMF Working Papers 05/120, International Monetary Fund.
    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.
    4. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
    5. Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany.
    6. Alberto Alesina & Guido Tabellini, 2005. "Why is fiscal policy often procyclical?," Harvard Institute of Economic Research Working Papers 2090, Harvard - Institute of Economic Research.
    7. Antonio Fatas & Ilian Mihov, 2009. "The Euro and Fiscal Policy," NBER Working Papers 14722, National Bureau of Economic Research, Inc.
    8. Morten O. Ravn & Harald Uhlig, 2002. "On adjusting the Hodrick-Prescott filter for the frequency of observations," The Review of Economics and Statistics, MIT Press, vol. 84(2), pages 371-375.
    9. Ricardo J. Caballero & Arvind Krishnamurthy, 2004. "Fiscal Policy and Financial Depth," NBER Working Papers 10532, National Bureau of Economic Research, Inc.
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