Fiscal Policy Effects and Capital Mobility in Latin American Countries

Abstract

This paper studies the relationship between the size of the fiscal multiplier and the degree of capital mobility in some Latin American countries. Mundell's (1963) andFleming's (1962) models show that this effect could be very large or small (close to zero) depending on the exchange rate and the degree of capital mobility, and the potency of a fiscal policy is inversely correlated with the degree of capital mobility. Based on Mora's (2013) model, we argue that the multiplier might not be negatively correlated with capital mobility in these countries. In other words, the potency of fiscal policy could be small because the degree of capital mobility in Latin American countries is quite low. The empirical findings support our hypothesis. We have found that the size of the fiscal multiplier tends to increase or (at least) to remain around 1.40 in these countries in the short run; however, in the long run, this effect tends to decrease significantly to 0.34. These results also suggest that the effectiveness of fiscal policies in Latin American countries are still large but could be larger if they become more financially integrated with the rest of the world. JEL Classifications: E62, E12, F41, O54

The government spending multiplier in Latin American countries: does the institutional environment matter?

“…When economic freedom, capital mobility and openness are all at their sample mean levels, the estimated multiplier is about 1.9. This is close to the estimates reported by Mora and Acevedo (2019). The economic freedom effect is intriguing because it can account for the coincidence of large multipliers and trade shares…”

“…The spending multiplier depends on the institutional/policy environment. Mora and Acevedo (2019) report that the government spending multiplier estimated based on Latin American data is notably higher than what is typically reported for developed economies. This result is intriguing in light of Latin American countries' proclivity for fiscal In this paper, we have explored why Latin American countries have large spending multipliers.…”

“…A recent study by Mora and Acevedo (2019) report that the fiscal multiplier estimated from Latin American data is larger than what is typically reported for developed countries. In this paper, we build upon the results of Mora and Acevedo (2019) and explore factors that condition the size of Latin American multipliers. In particular, we estimate the marginal effect of government spending changes conditional on three factors:…”

“…A recent study by Mora and Acevedo (2019) report that the fiscal multiplier estimated from Latin American data is larger than what is typically reported for developed countries. In this paper, we build upon the results of Mora and Acevedo (2019) and explore factors that condition the size of Latin American multipliers. In particular, we estimate the marginal effect of government spending changes conditional on three factors: economic freedom; capital mobility; and the trade share of GDP. …”

“…We use the Fraser Institute's Economic Freedom of the World (EFW) scores (Gwartney et al, 2019) as a measure of that institutional environment in a country. Mora and Acevedo (2019) suggest that multipliers might be relatively large in Latin America because of low levels of economic freedom. Because the institutional and policy environments are characterized by high degrees of government intervention, fiscal policy may be more potent.…”