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Effects of Pro-cyclical Fiscal Policy in Advanced Economies

*This is an independent research project I am recently conducting. This topic intrigues me because of the current U.S. fiscal policy under Trump Administration, which is pro-cyclical.

Empirical studies show that fiscal policies in advanced economies, both government spendings and tax policies, have been a-cyclical or counter-cyclical in general (e.g. Kaminsky, Reinhart, and Vegh, 2004; Frankel, Vegh, and Vuletin, 2013; Vegh and Vuletin, 2015). The implementation of such policy requires government to “save in good time” and “spend in bad time”. In practice, the government decreases public spending or increases tax rate during the “good time”, vice versa, so as to stabilize the business cycle and achieve long-term economic sustainability. In contrast, evidence from developing countries indicates that fiscal policies have been pro-cyclical in general, which risks the economy by reinforcing the output volatility and weakening government’s ability to finance in “bad time” (e.g. Gavin and Perotti, 1997; Riascos and Vegh, 2003). Some economists have argued that the reasons behind the pro-cyclical fiscal policy in developing countries are among limited access to the international credit market, political distortions, and institutional weakness (e.g. Tornell and Lane, 1999; Riascos and Vegh, 2003; Talvi and Vegh, 2005).

However, several advanced economies, where the market is relatively mature and the institutions are strong, sometimes favored the pro-cyclical fiscal policy, for example, recently in the United States. In addition to political concerns, what are the economic reasons behind such fiscal policies? What would be the effects of such policy practice to the whole economy? I am in process investigating these questions.


Frankel, Jeffrey A., Carlos A. Vegh, and Guillermo Vuletin, 2013, “On graduation from fiscal procyclicality”, Journal of Development Economics, Vol. 100, pp. 32-47.

Frankel, Jeffrey, Carlos A. Vegh, and Guillermo Vuletin, “Fiscal policy in developing countries: Escape from procyclicality,” VOX (June 2011). A shorter version of the preceding paper. Available at‐ developing‐nations‐escaped‐procyclical‐fiscal‐policy.

Gavin, Michael and Roberto Perotti, 1997, “Fiscal policy in Latin America”, NBER Macroeconomics Annual, Vol.12, pp. 11-61.

Kaminsky, Graciela L., Carmen M. Reinhart, and Carlos Vegh, 2004, “When it rains, it pours: Procyclical Capital Flows and Macroeconomic Policies”, NBER Macroeconomics Annual, Vol. 19. pp. 11-82.

Nouriel Roubini, 1997, “Supply Side Economics: Do Tax Rate Cuts Increase Growth and Revenues and Reduce Budget Deficits? Or Is It Voodoo Economics All Over Again?”, Stern School of Business, New York University:

Riascos, Alvaro and Carlos A. Vegh, 2003, “Procyclical government spending in developing countries: The role of capital market imperfections”, (mimeo, Banco Republica, Colombia and UCLA).

Talvi, Ernesto and Carlos A. Vegh, 2005, “Tax base variability and procyclicality of fiscal policy”, Journal of Development Economics, Vol. 78, pp. 156-190.

Tornell, Aaron and Philip R. Lane, 1999, “The voracity effect”, American Economic Review, Vol. 89, No. 1, pp. 22-46.

Vegh, Carlos A. and Guillermo Vuletin, 2015, “How is tax policy conducted over the business cycle?”, American Economic Journal, Economic Policy, Vol. 7 (August 2015), pp. 327-370.