Abstract:
According to standard economic theory, fiscal policy should be countercyclical. In the neoclassical smoothing model of Barro (1979), a government should optimally run surpluses in good times and deficits in bad times. That is the same a government should do, though for different reasons, in the standard Keynesian or neo-Keynesian framework.
Yet in practice governments often seem to follow a pro-cyclical fiscal policy. Cuddington (1989), Talvi and Vegh (2005) and Sinnott (2009), among others, document that governments save little or even disave in booms. Procyclicality is most evident in Latin America (Gavin et al (1996), Gavin and Perotti (1997), Stein et al (1999)) but is also present in OECD countries (Talvi and Vegh (2005), Arreaza et al (1999), Lane (2003)).