On graduation from …fiscal procyclicality: Forthcoming, Journal of Development Economics

CID Working Paper No. 248

Jeffrey A. Frankel
Carlos A. Vegh
Guillermo Vuletiny
July 2012

Abstract

In the past, industrial countries have tended to pursue countercyclical or, at worst, acyclical …fiscal policy. In sharp contrast, emerging and developing countries have followed procyclical …fiscal policy, thus exacerbating the underlying business cycle. We show that, over the last decade, about a third of the developing world has been able to escape the procyclicality trap and actually become countercyclical. We then focus on the role played by the quality of institutions, which appears to be a key determinant of a country’s ability to graduate. We show that, even after controlling for the endogeneity of institutions and other determinants of fi…scal procyclicality, there is a causal link running from stronger institutions to less procyclical or more countercyclical …fiscal policy.

JEL Classi…cation: E62, E32, E02, F41.

Keywords: business cycle, institutional quality, cyclicality, graduation, emerging markets.

Affiliated Research Program: Growth Lab