Determinants and consequences of fiscal procyclicality and sustainability

A countercyclical fiscal policy combined with sustainable fiscal finances is considered to be one of the most important objectives in modern economic policy. However, procyclical fiscal policy is widely observed in practice, especially in emerging market countries. The main purposes of this thesis are to examine the determinants of fiscal procyclicality and sustainability with special reference to the role of fiscal rules, and to assess the impact of both fiscal procyclicality and sustainability on economic growth. This thesis deals with several new issues on fiscal procyclicality and sustainability which have been ignored in the existing literature. We explore the role of the time coverage of fiscal rules in determining fiscal procyclicality and assess the effect of fiscal procyclicality on economic growth across spending categories and country groups. We also attempt to answer the determinants of fiscal sustainability and the effect of fiscal sustainability on economic growth for the first time. Our empirical analyses yield a number of novel and interesting findings. First, we find that government consumption and investment appear to be procyclical while current transfers appear to be countercyclical in a large number of OECD countries. Second, we find that most OECD countries seem to maintain sustainable fiscal finances and several factors such as the growth rate, the level of development, and aging populations could play a role in determining fiscal sustainability. Third, we find that procyclical current expenditure, especially government consumption and current transfers, could have a negative effect on economic growth, and this negative effect is prominent in emerging market countries. We also find that fiscal sustainability does not seem to play any role in economic growth in tranquil times. Finally, we find that the introduction of fiscal rules not only help achieve both countercyclical and sustainable fiscal policy, but also boost economic growth indirectly by stimulating countercyclical fiscal policy. Multi-year fiscal rules contribute more toward mitigating the level of fiscal procyclicality than annual fiscal rules, and fiscal rules with enforceability, such as the Stability and Growth Pact rules, appear to help maintain sustainable fiscal finances.