Abstract
AbstractThis paper analyzes whether fiscal policy in South Asia amplifies or smoothens business cycle fluctuations. It estimates several econometric models to explore the cyclicality of government spending and tax buoyancy. In South Asia, tax revenue increases less than one to one with changes in gross domestic product (GDP), but public spending increases more than proportionally. For each percentage point change in GDP growth, government expenditure changes by 1.3 percentage points. While changes in tax revenue have no significant impact on economic activity, the government spending multiplier is positive and significant: each additional US dollar (USD) of spending leads to an immediate increase in GDP of 0.2 USD and to an increase of 0.4 USD in the medium run. The impact of public spending on economic activity is entirely due to capital expenditure, which is also more procyclical. Procyclical public spending and a positive expenditure multiplier imply that fiscal policy in South Asia amplifies boom‐and‐bust cycles. These results are in line with those of other emerging markets and developing economies and robust to different model specifications and estimation strategies.
Highlights
Fiscal challenges are at the core of development challenges across South Asian countries
Procyclical public spending and a positive expenditure multiplier imply that fiscal policy in South Asia amplifies boom-and-bust cycles
Both tax revenue and government spending increase, but spending increases stronger than revenue
Summary
Fiscal challenges are at the core of development challenges across South Asian countries. Using a Panel VAR model and quarterly data for a large set of countries, Ilzetzki, Mendoza and Végh (2012) find that the government spending multiplier in developing countries is insignificant for consumption spending, but 0.6 on impact and 1.6 in the longrun for investment spending They show that multipliers tend to be larger in advanced economies, in countries with fixed exchange rates, in more closed economies, and in economies with lower levels of public debt. Since the correlation for overlapping years of the WDI and Asian Development Bank (ADB) series is very high for these countries (0.99 and 0.96 respectively), we exploit the ADB tax data to extend the WDI series using the growth rates This is the case for 2017 in Bhutan, as well as for years 1991-1996 and 2012-2017 in Pakistan.
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