"When it rains, it pours": fiscal policy, credit constraints and business cycles in emerging and developed economies

Fiscal procyclicality, meaning co-movement between government expenditure and macroeconomic fundamentals, is an important feature of business cycle dynamics for emerging and poor economies. I estimate a panel SVAR to investigate if fiscal policy leads to heightened volatility, reinforcing the cycle in emerging economies. The analysis also sheds light on the role of external financial constraints in shaping fiscal policy. My findings suggest that the response of emerging governments to output uctuations is similar to that of developed governments. However, emerging governments curtail spending in response to increases in the sovereign borrowing rate, which forces their consumption expenditure to act more procyclically. While I find evidence of higher fiscal discretion in emerging economies, the government consumption multiplier is substantially smaller for this group. For this reason, fiscal policy is responsible for a lower share of business cycle volatility in emerging economies than in developed ones.