The cyclical behaviour of fiscal policy: are developing countries different, and do institutions matter?
Abstract
The available empirical evidence shows that fiscal authorities commonly revert to procyclical fiscal policies instead of following the normative prescription of budgetary countercyclicality. The available empirical studies suggest that this phenomenon may be attributed to weak fiscal institutions. Hence, it is often advocated that strengthening institutions in the developing countries is a reliable way to improve the cyclical properties of fiscal policy. In this paper, we challenge this view by showing that the impact of institutions on the cyclical behaviour of fiscal policy is not uniform across all countries and differs significantly between advanced economies and the developing ones. In the latter, the impact of institutions on the quality of fiscal policy proves to be weak, which is in stark contrast to the strong relationship observed in developed economies. This surprising result suggests that the focus on improving institutional quality may be of little help as a tool to increase the countercyclicality of fiscal policy in the developing economies.
Keyword : procyclical fiscal policy, fiscal institutions
How to Cite
Mackiewicz, M. (2023). The cyclical behaviour of fiscal policy: are developing countries different, and do institutions matter?. Technological and Economic Development of Economy, 29(3), 796–813. https://doi.org/10.3846/tede.2023.18709
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Alesina, A., Favero, C., & Giavazzi, F. (2020). Austerity: When it works and when it doesn’t. Princeton University Press. https://doi.org/10.2307/j.ctvc77f4b
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Arellano, M., & Bond, S. (1991). Some tests of specification of panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies, 58(2), 277–297. https://doi.org/10.2307/2297968
Barro, R. (1979). On the determination of the public debt. Journal of Political Economy, 87(5), 940–947. https://doi.org/10.1086/260807
Baskaran, T., & Bigsten, A. (2013). Fiscal capacity and the quality of government in Sub-Saharan Africa. World Development, 45, 92–107. https://doi.org/10.1016/j.worlddev.2012.09.018
Bausch, R. D. (2019). Social capital and the cyclicality of government expenditure. International Journal of Trade and Global Markets, 12(3–4), 250–259. https://doi.org/10.1504/IJTGM.2019.101545
Bergman, M. U., Hutchison, M. M., & Jensen, S. E. H. (2016). Promoting sustainable public finances in the European Union: The role of fiscal rules and government efficiency. European Journal of Political Economy, 44, 1–19. https://doi.org/10.1016/j.ejpoleco.2016.04.005
Bergman, U. M., & Hutchison, M. (2020). Fiscal procyclicality in emerging markets: The role of institutions and economic conditions. International Finance, 23(2), 196–214. https://doi.org/10.1111/infi.12375
Biolsi, C., & Kim, H. Y. (2021). Analyzing state government spending: Balanced budget rules or forward-looking decisions? International Tax and Public Finance, 28(4), 1035–1079. https://doi.org/10.1007/s10797-020-09634-1
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Brambor, T., Clark, W. R., & Golder, M. (2005). Understanding interaction models: Improving empirical analyses. Political Analysis, 14(1), 63–82. https://doi.org/10.1093/pan/mpi014
Bruno, G. S. F. (2005). Estimation and inference in dynamic unbalanced panel-data models with a small number of individuals. Stata Journal, 5(4), 473–500. https://doi.org/10.1177/1536867X0500500401
Bun, M. J., & Kiviet, J. F. (2003). On the diminishing returns of higher-order terms in asymptotic expansions of bias. Economics Letters, 79(2), 145–152. https://doi.org/10.1016/S0165-1765(02)00299-9
Bystrov, V., & Mackiewicz, M. (2020). Recurrent explosive public debts and the long-run fiscal sustainability. Journal of Policy Modeling, 42(2), 437–450. https://doi.org/10.1016/j.jpolmod.2019.10.002
Calderón, C., Duncan, R., & Schmidt‐Hebbel, K. (2016). Do good institutions promote countercyclical macroeconomic policies? Oxford Bulletin of Economics and Statistics, 78(5), 650–670. https://doi.org/10.1111/obes.12132
Calderón, C., & Nguyen, H. (2016). The cyclical nature of fiscal policy in Sub-Saharan Africa. Journal of African Economies, 25(4), 548–579. https://doi.org/10.1093/jae/ejw007
Calderón, C., & Schmidt-Hebbel, K. (2003). Macroeconomic policies and performance in Latin America. Journal of International Money and Finance, 22(7), 895–923. https://doi.org/10.1016/j.jimonfin.2003.09.005
Canova, F., & Pappa, E. (2005). Does it cost to be virtuous? The macroeconomic effects of fiscal constraints (Working Paper No. 11065). National Bureau of Economic Research. https://doi.org/10.3386/w11065
Catao, L. A., & Sutton, B. W. (2002). Sovereign defaults: The role of volatility (Working Paper, 2002(149)). International Monetary Fund. https://doi.org/10.5089/9781451856903.001
Combes, J.-L., Minea A., & Sow, M. (2017). Is fiscal policy always counter- (pro-) cyclical? The role of public debt and fiscal rules. Economic Modelling, 65, 138–146. https://doi.org/10.1016/j.econmod.2017.05.017
Dumičić, M. (2019). Linkages between fiscal policy and financial (in) stability. Journal of Central Banking Theory and Practice, 8(1), 97–109. https://doi.org/10.2478/jcbtp-2019-0005
Elgin, C., Williams, C. C., Oz-Yalaman, G., & Yalaman, A. (2022). Fiscal stimulus packages to COVID-19: The role of informality. Journal of International Development, 34(4), 861–879. https://doi.org/10.1002/jid.3628
Eyraud, L., Gaspar, V., & Poghosyan, T. (2017). Fiscal politics in the euro area. (IMF Working Papers, 2017(018)). International Monetary Fund. https://doi.org/10.5089/9781475572919.001
Frankel, J. A., Vegh, C. A., & Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100(1), 32–47. https://doi.org/10.1016/j.jdeveco.2012.07.001
Gagnon, M. H., & Gimet, C. (2020). Unconventional economic policies and sentiment: An international assessment. The World Economy, 43(6), 1544–1591. https://doi.org/10.1111/twec.12916
Gavin, M., Hausmann, R., Perotti, R., & Talvi E. (1996). Managing fiscal policy in Latin America and the Caribbean: Volatility, procyclicality, and limited creditworthiness (Working Paper No. 326). Inter-American Development Bank.
Giavazzi, F., & Pagano, M. (1990). Can severe fiscal contractions be expansionary? Tales of two small European Countries. In O. Blanchard & S. Fischer (Eds.), NBER Macroeconomics Annual (vol. 5, pp. 75–111). MIT Press. https://doi.org/10.1086/654131
Gootjes, B., & de Haan, J. (2022). Procyclicality of fiscal policy in European Union countries. Journal of International Money and Finance, 120, 102276. https://doi.org/10.1016/j.jimonfin.2020.102276
Gootjes, B., de Haan, J., & Jong-A-Pin, R. (2021). Do fiscal rules constrain political budget cycles? Public Choice, 188(1), 1–30. https://doi.org/10.1007/s11127-020-00797-3
Jaillet, P., & Pfister, C. (2022). Better fiscal rules for a more integrated EMU. Intereconomics, 57(6), 377–383. https://doi.org/10.1007/s10272-022-1091-0
Ji, T., & Mei, D. (2021). Export diversification and fiscal procyclicality. Emerging Markets Finance and Trade, 57(2), 465–481. https://doi.org/10.1080/1540496X.2019.1589446
Judson, R. A., & Owen, A. L. (1999). Estimating dynamic panel data models: A guide for macroeconomists. Economics Letters, 65(1), 9–15. https://doi.org/10.1016/S0165-1765(99)00130-5
Kaminski, G., Reinhart, C., & Vegh, C. (2004). When it rains it pours: Procyclical capital flows and macroeconomic policies (NBER Working Paper, No. 10780). https://doi.org/10.3386/w10780
Kassouri, Y., & Altıntaş, H. (2021). Cyclical drivers of fiscal policy in sub-Saharan Africa: New insights from the time-varying heterogeneity approach. Economic Analysis and Policy, 70, 51–67. https://doi.org/10.1016/j.eap.2021.01.019
Kaufmann, D., Kraay, A., & Mastruzzi, M. (2010). The worldwide governance indicators: Methodology and analytical issues (World Bank Policy Research Working Paper No. 5430). World Bank.
Lledó, V., & Poplawski-Ribeiro, M. (2013). Fiscal policy implementation in sub-Saharan Africa. World Development, 46, 79–91. https://doi.org/10.1016/j.worlddev.2013.01.030
Mackiewicz, M. (2007). Making the stability pact more flexible: Does it lead to pro-cyclical fiscal policies? Fiscal Studies, 28(2), 251–268. https://doi.org/10.1111/j.1475-5890.2007.00056.x
Mackiewicz, M. (2023). The sustainability of fiscal policy in southern African countries – a comparative empirical perspective. International Journal of Emerging Markets, 18(2), 337–350. https://doi.org/10.1108/IJOEM-06-2020-0696
Mandon, P., & Cazals, A. (2019). Political budget cycles: Manipulation by leaders versus manipulation by researchers? Evidence from a meta‐regression analysis. Journal of Economic Surveys, 33(1), 274–308. https://doi.org/10.1111/joes.12263
Mawejje, J., & Odhiambo, N. M. (2020). The determinants of fiscal deficits: A survey of literature. International Review of Economics, 67(3), 403–417. https://doi.org/10.1007/s12232-020-00348-8
Onofrei, M., Bostan, I., Oprea, F., Paraschiv, G., & Lazăr, C. M. (2020). The implication of fiscal principles and rules on promoting sustainable public finances in the EU countries. Sustainability, 12(7), 2772. https://doi.org/10.3390/su12072772
Perotti, R. (2002). Estimating the effects if fiscal policy in OECD countries (Working Paper No. 15). European Network of Economic Policy Research Institute.
Persson, T., & Tabellini, G. (2000). Political economics: Explaining economic policy. MIT Press.
Persson, T., & Tabellini, G. (2005). The economic effects of constitutions. MIT Press.
Priewe, J. (2020). Why 3 and 60 per cent? The rationale of the reference values for fiscal deficits and debt in the European Economic and Monetary Union. European Journal of Economics and Economic Policies: Intervention, 17(2), 111–126. https://doi.org/10.4337/ejeep.2020.02.01
Roodman, D. (2009). How to do xtabond2: An introduction to difference and system GMM in Stata. Stata Journal, 9(1), 86–136. https://doi.org/10.1177/1536867X0900900106
Schaechter, A., Kinda, T., Budina, N., & Weber, A. (2012). Fiscal rules in response to the crisis – Toward the “Next-Generation” rules. A new dataset (IMF Working Paper 12/187). International Monetary Fund.
Sharma, C., & Mishra, R. K. (2022). On the good and bad of natural resource, corruption, and economic growth nexus. Environmental and Resource Economics, 82(4), 889–922. https://doi.org/10.1007/s10640-022-00694-x
Tornell, A., & Lane, P. R. (1998). Are windfalls a curse?: A non-representative agent model of the current account. Journal of International Economics, 44(1), 83–112. https://doi.org/10.1016/S0022-1996(97)00016-0
Turan, T., & Yanıkkaya, H. (2020). Natural resource rents and capital accumulation nexus: Do resource rents raise public human and physical capital expenditures? Environmental Economics and Policy Studies, 22(3), 449–466. https://doi.org/10.1007/s10018-020-00264-9
Woo, J. (2009). Why do more polarized countries run more procyclical fiscal policy? The Review of Economics and Statistics, 91(4), 850–870. https://doi.org/10.1162/rest.91.4.850
Yabré, T., & Semedo, G. (2021). Political stability and fiscal consolidation in sub‐Saharan African countries. The World Economy, 44(4), 1077–1109. https://doi.org/10.1111/twec.13077
Aizenman, J., Jinjarak, Y., Nguyen, H. T. K., & Park, D. (2019). Fiscal space and government-spending and tax-rate cyclicality patterns: A cross-country comparison, 1960–2016. Journal of Macroeconomics, 60, 229–252. https://doi.org/10.1016/j.jmacro.2019.02.006
Alesina, A., Favero, C., & Giavazzi, F. (2020). Austerity: When it works and when it doesn’t. Princeton University Press. https://doi.org/10.2307/j.ctvc77f4b
Alesina, A., & Tabellini, G. (2005). Why is fiscal policy often procyclical? (NBER Working Paper, No. 11600). https://doi.org/10.3386/w11600
Arellano, M., & Bond, S. (1991). Some tests of specification of panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies, 58(2), 277–297. https://doi.org/10.2307/2297968
Barro, R. (1979). On the determination of the public debt. Journal of Political Economy, 87(5), 940–947. https://doi.org/10.1086/260807
Baskaran, T., & Bigsten, A. (2013). Fiscal capacity and the quality of government in Sub-Saharan Africa. World Development, 45, 92–107. https://doi.org/10.1016/j.worlddev.2012.09.018
Bausch, R. D. (2019). Social capital and the cyclicality of government expenditure. International Journal of Trade and Global Markets, 12(3–4), 250–259. https://doi.org/10.1504/IJTGM.2019.101545
Bergman, M. U., Hutchison, M. M., & Jensen, S. E. H. (2016). Promoting sustainable public finances in the European Union: The role of fiscal rules and government efficiency. European Journal of Political Economy, 44, 1–19. https://doi.org/10.1016/j.ejpoleco.2016.04.005
Bergman, U. M., & Hutchison, M. (2020). Fiscal procyclicality in emerging markets: The role of institutions and economic conditions. International Finance, 23(2), 196–214. https://doi.org/10.1111/infi.12375
Biolsi, C., & Kim, H. Y. (2021). Analyzing state government spending: Balanced budget rules or forward-looking decisions? International Tax and Public Finance, 28(4), 1035–1079. https://doi.org/10.1007/s10797-020-09634-1
Bova, M. E., Carcenac, N., & Guerguil, M. M. (2014). Fiscal rules and the procyclicality of fiscal policy in the developing world (IMF Working Papers, 2014(122)). International Monetary Fund. https://doi.org/10.5089/9781498305525.001
Brambor, T., Clark, W. R., & Golder, M. (2005). Understanding interaction models: Improving empirical analyses. Political Analysis, 14(1), 63–82. https://doi.org/10.1093/pan/mpi014
Bruno, G. S. F. (2005). Estimation and inference in dynamic unbalanced panel-data models with a small number of individuals. Stata Journal, 5(4), 473–500. https://doi.org/10.1177/1536867X0500500401
Bun, M. J., & Kiviet, J. F. (2003). On the diminishing returns of higher-order terms in asymptotic expansions of bias. Economics Letters, 79(2), 145–152. https://doi.org/10.1016/S0165-1765(02)00299-9
Bystrov, V., & Mackiewicz, M. (2020). Recurrent explosive public debts and the long-run fiscal sustainability. Journal of Policy Modeling, 42(2), 437–450. https://doi.org/10.1016/j.jpolmod.2019.10.002
Calderón, C., Duncan, R., & Schmidt‐Hebbel, K. (2016). Do good institutions promote countercyclical macroeconomic policies? Oxford Bulletin of Economics and Statistics, 78(5), 650–670. https://doi.org/10.1111/obes.12132
Calderón, C., & Nguyen, H. (2016). The cyclical nature of fiscal policy in Sub-Saharan Africa. Journal of African Economies, 25(4), 548–579. https://doi.org/10.1093/jae/ejw007
Calderón, C., & Schmidt-Hebbel, K. (2003). Macroeconomic policies and performance in Latin America. Journal of International Money and Finance, 22(7), 895–923. https://doi.org/10.1016/j.jimonfin.2003.09.005
Canova, F., & Pappa, E. (2005). Does it cost to be virtuous? The macroeconomic effects of fiscal constraints (Working Paper No. 11065). National Bureau of Economic Research. https://doi.org/10.3386/w11065
Catao, L. A., & Sutton, B. W. (2002). Sovereign defaults: The role of volatility (Working Paper, 2002(149)). International Monetary Fund. https://doi.org/10.5089/9781451856903.001
Combes, J.-L., Minea A., & Sow, M. (2017). Is fiscal policy always counter- (pro-) cyclical? The role of public debt and fiscal rules. Economic Modelling, 65, 138–146. https://doi.org/10.1016/j.econmod.2017.05.017
Dumičić, M. (2019). Linkages between fiscal policy and financial (in) stability. Journal of Central Banking Theory and Practice, 8(1), 97–109. https://doi.org/10.2478/jcbtp-2019-0005
Elgin, C., Williams, C. C., Oz-Yalaman, G., & Yalaman, A. (2022). Fiscal stimulus packages to COVID-19: The role of informality. Journal of International Development, 34(4), 861–879. https://doi.org/10.1002/jid.3628
Eyraud, L., Gaspar, V., & Poghosyan, T. (2017). Fiscal politics in the euro area. (IMF Working Papers, 2017(018)). International Monetary Fund. https://doi.org/10.5089/9781475572919.001
Frankel, J. A., Vegh, C. A., & Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100(1), 32–47. https://doi.org/10.1016/j.jdeveco.2012.07.001
Gagnon, M. H., & Gimet, C. (2020). Unconventional economic policies and sentiment: An international assessment. The World Economy, 43(6), 1544–1591. https://doi.org/10.1111/twec.12916
Gavin, M., Hausmann, R., Perotti, R., & Talvi E. (1996). Managing fiscal policy in Latin America and the Caribbean: Volatility, procyclicality, and limited creditworthiness (Working Paper No. 326). Inter-American Development Bank.
Giavazzi, F., & Pagano, M. (1990). Can severe fiscal contractions be expansionary? Tales of two small European Countries. In O. Blanchard & S. Fischer (Eds.), NBER Macroeconomics Annual (vol. 5, pp. 75–111). MIT Press. https://doi.org/10.1086/654131
Gootjes, B., & de Haan, J. (2022). Procyclicality of fiscal policy in European Union countries. Journal of International Money and Finance, 120, 102276. https://doi.org/10.1016/j.jimonfin.2020.102276
Gootjes, B., de Haan, J., & Jong-A-Pin, R. (2021). Do fiscal rules constrain political budget cycles? Public Choice, 188(1), 1–30. https://doi.org/10.1007/s11127-020-00797-3
Jaillet, P., & Pfister, C. (2022). Better fiscal rules for a more integrated EMU. Intereconomics, 57(6), 377–383. https://doi.org/10.1007/s10272-022-1091-0
Ji, T., & Mei, D. (2021). Export diversification and fiscal procyclicality. Emerging Markets Finance and Trade, 57(2), 465–481. https://doi.org/10.1080/1540496X.2019.1589446
Judson, R. A., & Owen, A. L. (1999). Estimating dynamic panel data models: A guide for macroeconomists. Economics Letters, 65(1), 9–15. https://doi.org/10.1016/S0165-1765(99)00130-5
Kaminski, G., Reinhart, C., & Vegh, C. (2004). When it rains it pours: Procyclical capital flows and macroeconomic policies (NBER Working Paper, No. 10780). https://doi.org/10.3386/w10780
Kassouri, Y., & Altıntaş, H. (2021). Cyclical drivers of fiscal policy in sub-Saharan Africa: New insights from the time-varying heterogeneity approach. Economic Analysis and Policy, 70, 51–67. https://doi.org/10.1016/j.eap.2021.01.019
Kaufmann, D., Kraay, A., & Mastruzzi, M. (2010). The worldwide governance indicators: Methodology and analytical issues (World Bank Policy Research Working Paper No. 5430). World Bank.
Lledó, V., & Poplawski-Ribeiro, M. (2013). Fiscal policy implementation in sub-Saharan Africa. World Development, 46, 79–91. https://doi.org/10.1016/j.worlddev.2013.01.030
Mackiewicz, M. (2007). Making the stability pact more flexible: Does it lead to pro-cyclical fiscal policies? Fiscal Studies, 28(2), 251–268. https://doi.org/10.1111/j.1475-5890.2007.00056.x
Mackiewicz, M. (2023). The sustainability of fiscal policy in southern African countries – a comparative empirical perspective. International Journal of Emerging Markets, 18(2), 337–350. https://doi.org/10.1108/IJOEM-06-2020-0696
Mandon, P., & Cazals, A. (2019). Political budget cycles: Manipulation by leaders versus manipulation by researchers? Evidence from a meta‐regression analysis. Journal of Economic Surveys, 33(1), 274–308. https://doi.org/10.1111/joes.12263
Mawejje, J., & Odhiambo, N. M. (2020). The determinants of fiscal deficits: A survey of literature. International Review of Economics, 67(3), 403–417. https://doi.org/10.1007/s12232-020-00348-8
Onofrei, M., Bostan, I., Oprea, F., Paraschiv, G., & Lazăr, C. M. (2020). The implication of fiscal principles and rules on promoting sustainable public finances in the EU countries. Sustainability, 12(7), 2772. https://doi.org/10.3390/su12072772
Perotti, R. (2002). Estimating the effects if fiscal policy in OECD countries (Working Paper No. 15). European Network of Economic Policy Research Institute.
Persson, T., & Tabellini, G. (2000). Political economics: Explaining economic policy. MIT Press.
Persson, T., & Tabellini, G. (2005). The economic effects of constitutions. MIT Press.
Priewe, J. (2020). Why 3 and 60 per cent? The rationale of the reference values for fiscal deficits and debt in the European Economic and Monetary Union. European Journal of Economics and Economic Policies: Intervention, 17(2), 111–126. https://doi.org/10.4337/ejeep.2020.02.01
Roodman, D. (2009). How to do xtabond2: An introduction to difference and system GMM in Stata. Stata Journal, 9(1), 86–136. https://doi.org/10.1177/1536867X0900900106
Schaechter, A., Kinda, T., Budina, N., & Weber, A. (2012). Fiscal rules in response to the crisis – Toward the “Next-Generation” rules. A new dataset (IMF Working Paper 12/187). International Monetary Fund.
Sharma, C., & Mishra, R. K. (2022). On the good and bad of natural resource, corruption, and economic growth nexus. Environmental and Resource Economics, 82(4), 889–922. https://doi.org/10.1007/s10640-022-00694-x
Tornell, A., & Lane, P. R. (1998). Are windfalls a curse?: A non-representative agent model of the current account. Journal of International Economics, 44(1), 83–112. https://doi.org/10.1016/S0022-1996(97)00016-0
Turan, T., & Yanıkkaya, H. (2020). Natural resource rents and capital accumulation nexus: Do resource rents raise public human and physical capital expenditures? Environmental Economics and Policy Studies, 22(3), 449–466. https://doi.org/10.1007/s10018-020-00264-9
Woo, J. (2009). Why do more polarized countries run more procyclical fiscal policy? The Review of Economics and Statistics, 91(4), 850–870. https://doi.org/10.1162/rest.91.4.850
Yabré, T., & Semedo, G. (2021). Political stability and fiscal consolidation in sub‐Saharan African countries. The World Economy, 44(4), 1077–1109. https://doi.org/10.1111/twec.13077