Procyclical Fiscal Policy: Shocks, Rules, and Institutions: A View From Mars

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper assesses the roles of shocks, rules, and institutions as possible sources of procyclicality in fiscal policy. By employing parametric and nonparametric techniques, I reach the following four main conclusions. First, policymakers' reactions to the business cycle is different depending on the state of the economy-fiscal policy is "acyclical" during economic bad times, while it is largely procyclical during good times. Second, fiscal rules and fiscal responsibility laws tend to reduce the deficit bias on average, and seem to enhance, rather than to weaken, countercyclical policy. However, the evidence also suggests that fiscal frameworks do not exert independent effects when the quality of institutions is accounted for. Third, strong institutions are associated to a lower deficit bias, but their effect on procyclicality is different in good and bad times, and it is subject to decreasing returns. Fourth, unlike developed countries, fiscal policy in developing countries is procyclical even during (moderate) recessions; in "good times," however, fiscal policy is actually more procyclical in developed economies. JEL Classification Numbers: E62, E63, H62, C45, D78

Productivity shocks, stabilization policies and the dynamics of net foreign assets

“…The use of primary-deficit feedback rules has become increasingly popular to characterize discretionary fiscal policy in recent empirical analyses (See, among the others, Favero and Monacelli, 2005, Galí and Perotti, 2003, and Manasse, 2006. We use such specification to investigate the dynamic and cyclical implications of fiscal policy as a stabilization tool, and set the target primary deficit as a counter-cyclical response to the output gap and the stock of public debt (i.e.…”

“…However, there is widely documented emprical evidence, both in the US and the Euro Area, that fiscal policy has been often conducted in a countercyclical way (Galí-Perotti, 2003), without even mentioning the huge discretionary fiscal measures undertaken by most countries following the severe 2008-2009 world recession. A qualitative study of the propagation mechanism induced by different fiscal feedback rules on the main macroeconomic variables following productivity shocks can be useful for future more extensive evaluations of the empirical performance of such rules along the lines of Favero-Monacelli (2005) and Manasse (2006).…”

Fiscal Policy Stance in the European Union: The Impact of the Euro

“…In spite of the consensus that fiscal policy should be geared in a counter-cyclical manner over the cycle, evidence of pro-cyclical behaviour is quite common. Alesina and Tabellini (2005), Talvi and Vegh (2005), Manasse (2006) find evidence of pro-cyclical fiscal behaviour in developing countries. Turrini (2008) analyses the cyclical behaviour of fiscal policy in euro-area countries over the 1980-2005 period.…”

The impact of supranational fiscal rules on public finance: the case of EMU member states

“…Namely, the rules also apply at the level of individual countries, i.e., the national and lower levels (local and regional). Studies by e.g., von Hagen (2005), Manasse (2006), Hallerberg et al (2007), Debrun and Kumar (2007) and Ayuso-i-Casals et al (2008) show that strictly structured fiscal institutions and fiscal rules at the level of individual countries lead to higher discipline by the fiscal authorities.…”