Fiscal Policy in Developing Countries : A Framework and Some Questions

Abstract

This paper surveys fiscal policy in
 developing countries from the point of view of long-run
 growth. The first section reviews existing methodologies to
 estimate the effects of fiscal policy shocks and of
 systematic fiscal policy, with time series or with
 cross-sectional methods, and their applicability to
 developing countries. The second section surveys optimal
 fiscal policy in developing countries, by considering the
 role of the intertemporal government budget, and
 sustainability and solvency. It also reviews the fuzzy
 debate on "fiscal space" and "macroeconomic
 space" - and the usefulness (or lack thereof) of these
 terms for policy analysis. The third section asks what
 theory tells us about the optimal cyclical behavior of
 fiscal policy in developing countries. It shows that it very
 much depends on the assumptions about the interactions
 between credit market imperfections at the individual,
 firms, or government level, and on the supply of external
 funds to the country. Different sets of assumptions lead to
 different implications about optimal cyclical behavior. The
 available evidence on the cyclical behavior of fiscal
 policy, and possible reasons for the observed prevalence of
 a procyclical behavior in developing countries, is also
 reviewed. If one agrees that fiscal policy is indeed less
 countercyclical than we think is optimal, the issue is how
 to correct the problem. One obvious question is why
 government do not self-insure, i.e. why they do not
 accumulate assets in upturns and decumulate them in
 downturns. This leads to the analysis of fiscal rules and
 stabilization funds, in the fourth section. The last
 section concludes with what the author considers important
 research and policy questions in each part.