Fiscal policy cycles and the exchange rate regime in developing countries

Abstract

The paper studies empirically fiscal policies around elections in 25 developing countries as affected by the exchange rate regime. The purpose is to consider whether countries with flexible exchange regimes are less likely to engage in expansionary fiscal policies before elections because such policies can result in devaluations and inflation which affect government popularity adversely. The empirical results show that governments indeed try to improve their re-election prospects by expansionary fiscal policies, but only in countries with fixed exchange rates and adequate reserve levels. For some countries, this raises doubts about the usefulness of fixed exchange rates for stabilizing the macro economy, unless reforms of the institutional framework reduce the scope for election-oriented fiscal expansion.