TY  - JOUR
AU  - Ilzetzki,Ethan
AU  - Vegh,Carlos A.
TI  - Procyclical Fiscal Policy in Developing Countries: Truth or Fiction?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14191
PY  - 2008
Y2  - July 2008
UR  - http://www.nber.org/papers/w14191
L1  - http://www.nber.org/papers/w14191.pdf
N1  - Author contact info:
Ethan Ilzetzki
London School of Economics
Houghton Street
London WC2A 2AE
Tel: +44 (0) 20-7955-7510
E-Mail: e.ilzetzki@LSE.ac.uk

Carlos A. Vegh
Department of Economics
Tydings Hall, Office 4118G
University of Maryland
College Park, MD 20742-7211
Tel: 301-405-3546
Fax: 301-405-3542
E-Mail: vegh@econ.bsos.umd.edu
AB  - A large empirical literature has found that fiscal policy in developing countries is procyclical, in contrast to high-income countries where it is countercyclical. The idea that fiscal policy in developing countries is procyclical has all but reached the status of conventional wisdom. This has sparked a growing theoretical literature that attempts to explain such a puzzle. Some authors, however, have suggested that procyclical fiscal policy could be more fiction than truth since, by and large, the current literature has ignored endogeneity problems and may have simply misidentified a standard expansionary effect of fiscal policy. To settle this issue of causality, we build a novel quarterly dataset for 49 countries covering the period 1960-2006, and subject the data to a battery of econometric tests: instrumental variables, simultaneous equations, and time-series methods.  We find overwhelming evidence to support the idea that procyclical fiscal policy in developing countries is in fact truth and not fiction.  We also find evidence that fiscal policy is expansionary -- a channel disregarded by the existing literature -- lending empirical support to the notion that when "it rains, it pours."
ER  -