The paper sheds light on the debate regarding the relative role of the lack of financial integration and weak institutions on the observed procyclicality of fiscal policy in many developing countries. Employing panel regressions with multiplicative terms for 109 countries for the period 1985-2009, we show that the relative strength of the two explanations, financial integration or institutions, is contingent on the state of the economy. Our results suggest the level of quality of institutions mainly drive the behavior of the cyclicality of fiscal policy in good times whereas both financial integration and institutions are important in the ability of countries to run counter-cyclical fiscal policy during bad times.
This article examines the empirical link between fiscal policy and the current account focusing on microstates defined as countries with a population of less than 2 million between 1970 and 2009. This article employs panel regression and Panel Vector Autoregression (PVAR) on 155 countries of which 42 are microstates. Panel regression results show that a percentage point improvement in the fiscal balance improves the current account balance by 0.4 percentage points of Gross Domestic Product (GDP). The real effective exchange rate has no significant impact on the current account in microstates but the coefficient is significant in the global sample. PVAR results show that an increase in government consumption results in real exchange appreciation, but the effect on the current account after an initial deterioration dies out quicker in microstates than in the global sample. The result implies that fiscal policy has little effect on the current account in microstates beyond its direct impact on imports. Overall, the results suggest that the weak relative price effects make the effect of fiscal adjustment on the current account much more difficult in microstates.
The Effects of Government Spending Shocks in Developing Countries
We identify government spending shocks and examine their effects on certain macroeconomic variables in 17 developing countries. The output multipliers are also calculated. Identification is achieved through a sign restriction method that requires positive impact period response of government spending, output, deficit and tax revenue in Vector Autoregression (VAR) model. Our results show that an increase in government spending would lead to a short-lived expansion of output and consumption, an immediate deterioration of net exports, and an appreciation or no effect on exchange rate. Furthermore, the calculated output multipliers give higher values in the impact period that diminish quickly in the subsequent periods. The findings suggest fiscal stimulus in the developing countries might have a positive impact on output and consumption, however these effects seem to be short-lived.
Transmission Mechanisms of Government Spending Shocks in Developing Countries[Work in Progress]