Procyclicality of fiscal policy in emerging countries: the cycle is the trend
Economic research on fiscal policy has shown that while developed economies tend to run countercyclical fiscal policies Latin American countries have been characterized by procyclical policies. One of the explanations given to this phenomenon is that high external debt causes severe constraints on the ability to secure new loans which forces countries to cut their budget deficits. Another explanation is related to optimal behavior under political constraints (Talvi and Végh 2005). In this paper we test a different channel related to the characteristics of business cycles. Aguiar and Gopinath (2007) find that in developing countries the cycle is the trend—that is business cycles tend to become persistent and thus to determine the fundamentals of economic performance in these countries. One possible channel is fiscal policy: in times of recession the erratic character of the crisis forces developing economies to cut expenditures while the opposite occurs during booms. This procyclical behavior may characterize other sectors of the economy far beyond the fiscal policy reaction (Kaminsky Reinhart and Végh 2005).