Fiscal Policy, Business Cycles and Economic Stabilisation: Evidence from Industrialised and Developing Countries

This paper empirically investigates the responsiveness of fiscal policy to business cycles and the effectiveness of fiscal policy in reducing economic fluctuations. From regressions on the responsiveness of fiscal policy to business cycles, we find that the government's current expenditures and...

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Bibliographic Details
Published in:Fiscal studies 2007-12, Vol.28 (4), p.437-462
Main Authors: Lee, Young, Sung, Taeyoon
Format: Article
Language:English
Subjects:
Bias
Business cycles
Capital expenditures
Cross-national analysis
Developing countries
Economic development
Economic fluctuations
Economic growth rate
Economic impact analysis
Economic policy
Economic stabilization
Estimated taxes
Financial economics
Fiscal policy
GDP
Government spending
Gross Domestic Product
Income taxes
Industrialized nations
LDCs
Macroeconomics
Military spending
Petroleum production
Public finance
Stabilization policy
Studies
Subsidies
Taxes
Trends
Variables
Volatility
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Summary:This paper empirically investigates the responsiveness of fiscal policy to business cycles and the effectiveness of fiscal policy in reducing economic fluctuations. From regressions on the responsiveness of fiscal policy to business cycles, we find that the government's current expenditures and subsidies & transfers move counter-cyclically, whereas taxes and capital expenditures move pro-cyclically. Using economic fluctuations in neighbouring countries as an instrumental variable, we show that ordinary least squares (OLS) estimates understate the responsiveness of fiscal policy to economic fluctuations. We also find that fiscal policy responds asymmetrically over economic fluctuations. In investigating the effectiveness of fiscal policy in reducing economic fluctuations, we mitigate omitted variable bias by adding four important factors – military expenditures, oil production, economic fluctuations in neighbouring countries and fiscal policy responsiveness to business cycles. The results of effectiveness regressions are consistent with the responsiveness regressions, highlighting the importance of current expenditures, especially subsidies and transfers, in responding to business cycles and stabilising the economy.
ISSN:0143-5671
1475-5890
DOI:10.1111/j.1475-5890.2007.00063.x