Cyclical drivers of fiscal policy in sub-Saharan Africa: New insights from the time-varying heterogeneity approach

Abstract

We extend the topical literature on the cyclical behavior of fiscal policy in developing countries subject to terms of trade cycles by applying the interactive fixed effects model that allow for unobserved time-varying heterogeneity in the impact of fundamentals. Based on a sample of 20 sub-Saharan African (SSA) countries from 1985 to 2017, our results support existing evidence about developing countries that fiscal policy is pro-cyclical in SSA countries. Whereas this pro-cyclicality is valid for government spending and fiscal balance, government revenue is slightly counter-cyclical. We also find that the pro-cyclicality of government expenditure and fiscal balance escalates during episodes of terms of trade booms. Our results make a strong case for the support of the pivotal role of Sovereign Wealth Funds, access to international financial markets, and flexible exchange rate regimes in reversing the pro-cyclical behavior of fiscal policy.