Does Democracy Affect Cyclical Fiscal Policy? Evidence From Developing Countries

Macroeconomics usually prescribes counter-cyclical fiscal policies to stabilise the economy: government spending should increase above trend in the economic downturns, and decrease below trend during booms. Yet, empirical research has documented pro-cyclical fiscal policy in several democratic developing countries. This article uses updated data to analyse 63 developing countries from 1980 to 2013 and robustly shows that pro-cyclical fiscal policy does exist in both democratic and non-democratic developing countries. The essence of this paper is controlling endogeneity issue by the instrumental variable method and investigating the interaction between democracy, its maturity and quality of institutions in affecting fiscal policy cyclical.We provide 3 main findings. Firstly, an improvement in the level of institutions quality plays an important role to restrain pro-cyclical fiscal policy and these effects are larger in democratic countries than non-democratic ones. Additionally, more mature and stable democratic countries tend to implement less pro-cyclical fiscal policy.