Cross-Country Evidence on Determinants of Fiscal Policy Effectiveness –The Role of Capital Flows and a Country's International Trade and Financial Position

This paper studies the determinants of size differentials between fiscal multipliers in countries around the world, both advanced and developing economies. Besides domestic conditions and exchange rate regimes, we also introduce variables not before considered for explaining multiplier size differentials such as capital flows and the openness of capital markets in this context. We also disaggregate GDP into its main components in order to identify the channels through which external and internal factors can influence GDP after a change in fiscal policy. Our results point to the existence of a new channel through which fiscal policy effectiveness is affected. Capital flows, especially FDI flows, seem to play an important role in determining the sizes of fiscal multipliers, and a country's external conditions seem to largely explain GDP changes after fiscal expenditure shock. Our results also point toward a strong link between a country's international position and its real economy, providing important hints for policymakers on how to effectively use scarce fiscal resources.