The political economy of fiscal procyclicality

It is well-recognized that fiscal spending in developing countries tends to display significant procyclicality (increased spending during expansions and vice versa), in contravention of rational stabilization policy. Theoretical explanations have relied on either financial access or political-economic factors to justify this phenomenon. In this paper, we model the fiscal-output relationship as a dcc-garch process, and inquire whether debt or political economy constraints play a comparatively more important role in conditioning this correlation. Our evidence favors a positive effect from political economy, with weaker and more mixed results pertaining to financial access. Somewhat surprisingly, we also find that politics-induced procyclicality appears to be driven by advanced economies, and fiscal rules exacerbate procyclical tendencies.