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Rent seeing distortions and fiscal procyclicality

Ilzetzki, Ethan (2006): Rent seeing distortions and fiscal procyclicality.

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Abstract

Several empirical studies have found that government expenditures are procyclical in developing countries, unlike the countercyclical expenditures observed in high- income countries. We develop a dynamic political economy model to explain this phenomenon. In the model, governments provide public insurance to uninsured households, and Pareto-effcient and time-consistent redistributive policies are countercyclical. The introduction of a political friction, in which alternating governments disagree on the desired redistributive policy, can lead to procyclical transfer policies. In numerical simulations, the model successfully captures the cyclicality of government expenditures,tax revenues, and de�cits observed in the data for both high-income and developing countries. Simulations also allow a quantitative comparison with other common explanations for fiscal procyclicality. We �nd that without the political friction, borrowing constraints and differences in macroeconomic volatility cannot account for the differences in fiscal policy across countries in this setting.

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