Michael M. Hutchison, UC Santa Cruz Title: Fiscal Rules and Business Cycles in Emerging and Developing Economies
Abstract: Emerging and developing economies generally have greater economic volatility than advanced economies, but have experienced a substantial dampening of the business cycle since the early 2000s. Fiscal pro-cyclicality has also declined markedly in emerging market economies. We investigate whether fiscal rules, working to increase stability in public sector finances, may have allowed governments to follow less pro-cyclical fiscal policies. Chile is a well-known success story in this regard, with its adoption of strict policy rules regulating government expenditures, taxation and debt. We investigate whether adopting rules-constrained fiscal policy similar to Chile has helped reduce the procyclicality of fiscal policy and thereby dampened business cycle fluctuations. To this end, we employ a dynamic panel framework with 101 countries over 1985-2013. We also investigate whether the effectiveness of fiscal rules is contingent upon the quality of government institutions, and which specific type of fiscal rule (expenditure, revenue, balanced budget or debt rules) appears most effective. In addition, we control for other factors that may impact fiscal cyclicality and the effectiveness of fiscal rules, i.e. inflation targeting, IMF programs, terms-of-trade changes and the level of government debt. We find that fiscal rules are effective in reducing pro-cyclicality if implemented in countries with relatively high quality government bureaucracies (advanced and emerging market economies). The converse also holds – higher government efficiency reduces procyclicality but the effect is much stronger when combined with fiscal rules. We also find that balanced budget rules appear the most effective in reducing fiscal pro-cyclicality for a broad group of countries, but only expenditure rules appear effective in the developing-country group. Rules are also most effective in countries with particularly high government debt burdens and in those experiencing large terms-of-trade volatility. paper jointly with U. Michael Bergman