Cyclical expenditure policy, output volatility and economic growth

This article provides an empirical assessment of the relation between the cyclicality of fiscal expenditure policy, output volatility and economic growth, using a cross-section of 88 countries over the period 1960 to 2004. Identification of the effects of (endogenous) cyclical expenditure policy is achieved by exploiting the exogeneity of countries’ political and institutional characteristics, which we find to be relevant determinants of the cyclicality of expenditures. There are three main results: first, both pro- and countercyclical expenditure policy amplify output volatility, much in a way like pure fiscal shocks; second, output volatility, due to variations in cyclical and discretionary fiscal policy, is negatively associated with economic growth; third, there is no direct effect of cyclicality on economic growth other than through output volatility.