Fiscal Policy and Economic Activity in South Asia

Abstract

This paper analyzes whether fiscal policy in South Asia amplifies or smooths business cycle fluctuations. The paper estimates several econometric models to explore the cyclicality of government spending and tax buoyancy. The findings show that fiscal policy is procyclical in most countries. In South Asia, tax revenue increases less than one to one with gross domestic product, but public spending increases more than proportionally. While changes in tax revenue have no significant impact on economic activity, the government spending multiplier is positive and significant: an additional 1 USD of spending leads to an immediate increase in gross domestic product of 0.3 USD and a cumulative increase of 0.6 USD. 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.