Why Is Fiscal Policy Often Procyclical?

Abstract

Fiscal policy is procyclical in many developing countries. We explain this policy failure with a political agency problem. Procyclicality is driven by voters who seek to “starve the Leviathan” to reduce political rents. Voters observe the state of the economy but not the rents appropriated by corrupt governments. When they observe a boom, voters optimally demand more public goods or lower taxes, and this induces a procyclical bias in fiscal policy. The empirical evidence is consistent with this explanation: Procyclicality of fiscal policy is more pronounced in more corrupt democracies. (JEL: E62, D73, D78)

Fiscal and monetary policies in the BRICS: A panel VAR approach

“…As for the works about fiscal policy in emerging markets, Gavin and Perotti (1997), Talvi and Végh (2005), Alesina et al (2008) and Ilzetski and Vegh (2008) argue that high inflation and fiscal policy procyclicality remain serious policy issues. Velasco (2000) also point to the relevance of the fiscal bias, as government net assets tend to decrease over the business cycle in this group of countries.…”

Does the exchange rate regime matter for real shocks? Evidence from windstorms and earthquakes

“…16 I am grateful to an anonymous referee for suggesting this specification. 17 See the large literature on the cyclicality of fiscal policy for a discussion of these measurement issues, especially Kaminsky et al (in press), Gavin and Perotti (1997) and Alesina and Tabellini (2005). 18 I also ran regressions using the real growth rates of the various expenditures measures using CPI based inflation.…”

The Credibility of Fiscal Rules Policy and Business Cycle Volatility

“…Both studies find that government size and output volatility have a negative relationship indicating that the larger-government economies, the milder the economic fluctuations (Debrun et al, 2008). Alesina et al (2008) recognize that revenues and surpluses are insignificant publicsector variables. Using government expenditures only, they show that the counter-cyclical fiscal policy is conducted by developed countries whereas pro-cyclical fiscal policy is engaged in less developed countries.…”