Jeffrey A. Frankel
James W. Harpel Professor of Capital Formation and Growth
On Graduation from Fiscal Procyclicality
Frankel, Jeffrey A., Carlos A Vegh, and Guillermo Vulentin. "On Graduation from Fiscal Procyclicality." HKS Faculty Research Working Paper Series RWP12-011, April 2012.
In the past, industrial countries have tended to pursue countercyclical or, at worst, acyclical
fiscal policy. In sharp contrast, emerging and developing countries have followed procyclical fiscal
policy, thus exacerbating the underlying business cycle. We show that, over the last decade,
about a third of the developing world has been able to escape the procyclicality trap and actually
become countercyclical. In line with existing literature, we confirm the role of increased financial
integration and lower output volatility in reducing overall procyclicality. In this paper, however,
we focus on the role played by the quality of institutions. Indeed, the quality of institutions
seems to be a key determinant of a country's ability to graduate. We provide a formal analysis,
controlling for the endogeneity of institutions and other determinants of fiscal procyclicality, that
strongly suggests that there is a causal link running from stronger institutions to less procyclical
or more countercyclical fiscal policy.