Fiscal Policy in an Emerging Market Business Cycle Model

Ghate, Chetan and Gopalakrishnan, Pawan and Tarafdar, Suchismita (2014): Fiscal Policy in an Emerging Market Business Cycle Model.

Abstract

Emerging market economy business cycles are typically characterized by high consumption and output volatility, strongly counter-cyclical current accounts, and counter-cyclical real interest rates. Evidence from the wider EME and less developed economy business cycle experience suggests however that real interest rates can also be pro-cyclical. We reconcile the pro-cyclicality of real interest rates with the above facts by embedding fiscal policy into a standard emerging market business cycle model. We show that fiscal policy makes real interest rates a-cyclical or pro-cyclical. We use the model to replicate qualitatively some of the key features of the Indian business cycle.

• Item Type: MPRA Paper
• Language: English
• Keywords: Emerging Market Business Cycles, Fiscal Policy in a Small Open Economy, Indian Business Cycle, Interest Rate Shocks, Macroeconomic Stabilization
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; H - Public Economics > H2 - Taxation, Subsidies, and Revenue

References

Agénor, Pierre-Richard., McDermott, C.John, and Prasad, Eswar S., "Macroeconomic Fluctuations in developing countries: some stylized facts",World Bank Economic Review (14) (2000), pp. 251-285

Aguiar, Mark., and Gopinath, Gita, "Emerging market business cycles: The cycle is the trend", Journal of Political Economy ( 115)(1) (2007); pp 69-102

Ambler, Steve, and Paquet, Alain, "Fiscal spending shocks, endogenous government spending, and real business cycles" Journal of Economic Dynamics and Control ( 20) (1-3) (1996); pp 237-256

Barro, Robert J., "Output e¤ects of government purchases" Journal of Political Economy (89) (1981); pp 1086-1121 Bhattacharya, Rudrani, Patnaik, Ila, and Pundit, Madhavi, "Emerging economy business cycles: Financial integration and terms of trade shocks", Working paper No. 2013/120, National Institute of Public Finance and Policy (2013).

CEIC Indian Premium Database (2012), http://www.ceicdata.com/en/countries/india

Christiano, Lawrence J., and Eichenbaum, Martin, "Current real business cycle theories and aggregate labor market Fluctuations" American Economic Review ( 82) (1992); pp. 430-450

Cuadra, Gabriel, Sanchez, Juan, and Sapriza, Horacio,"Fiscal Policy and Default Risk in Emerging Markets," Review of Economic Dynamics (13)(2) (2010); pp. 452-469

Frankel, Jeffrey A., Vegh, Carlos A., and Vuletin Guillermo, "On graduation from Fiscal procyclicality" Journal of Development Economics (100) (2013); pp. 32-47

Gali, Jordi "Government size and macroeconomic stability" European Economic Review (38) (1994); pp. 117-132

Ghate, Chetan, Pandey, Radhika and Patnaik, Ila, "Has Indian emerged? Business cycle stylized facts from a transitioning economy" Structural Change and Economic Dynamics (24) (2013); pp. 157-172

Ghate, Chetan, Glomm, Gerhard and Liu, Jialu, "Sector infrastructure investment in an unbalanced growing economy: The case of India" working paper (2012) 32

Greenwood, Jeremy, Hercowitz, Zvi, and Hu¤man, Gregory W., "Investment, capacity utilization, and the real business cycle" American Economic Review (78)(3) (1988); pp. 402-417

Handbook of Statistics of the Indian Economy, Reserve Bank of India (2012)

Kuehlwein, Michael, "Evidence on the substitutability between government purchases and consumer spending within specific spending categories" Economics Letters (58) (1998); pp. 325-329

Lane, Philip R., "The cyclical behaviour of fiscal policy: evidence from the OECD" Journal of Public Economics (87) (2003); pp. 2661-2675

Li, Nan, "Cyclical wage movements in emerging markets compared to developed economics: The role of interest rates" Review of Economic Dynamics (14) (2011); pp. 686-704

Loayza, N., Ranciére, R., Servén, L., and Ventura, J., "Macroeconomic volatility and welfare in developing countries: An introduction" The World Bank Economic Review (21)(3) (2007); pp. 343-357

Male, Rachel, "Developing country business cycles: Revisiting the stylized facts",Working paper no. 664, School of Economics and Finance, Queen Mary University of London (2010)

Neumeyer, P.A., and Perri, F., "Business cycles in emerging economies: The role if interest rates" Journal of Monetary economics ( 52) (2005); pp. 345-380

Ni, Shawn, "An empirical analysis on the substitutability between private consumption and government purchases" Journal of Monetary economics ( 36) (1995); pp. 593-605

Penn World Tables Version 8.0, http://www.rug.nl/research/ggdc/data/penn-world-table (2014) Poirson, Héléne, "The Tax Systemin India: Could ReformSpur Growth?" IMF Working Paper WP/06/93 (2006)

Prescott, Edward C., "Prosperity and Depression: 2002 Richard T. Ely Lecture,"Working Papers 618, Federal Reserve Bank of Minneapolis (2002)

Rand, J., and Tarp, F., "Business cycles in developing countries: Are they different?" World Development (30)(12) (2002), pp. 2071-2088

Reuters India database, http://in.reuters.com/article/2013/06/10/india-plr-idINL3N0EM1YU20130610?type=companyNews

Roche, Maurice J., "Government spending and the international business cycle" Canadian Journal of Economics (29)(4) (1996); pp. 865-884

Talvi, Ernesto, and Vegh, Carlos. A, "Tax Base Variability and Procyclicality of Fiscal Policy" Journal of Development Economics (78)(1) (2005); pp. 156-190

Tiryaki, S. Tolga, "Interest rates and real business cycles in emerging markets" The B.E. Journal of Macroeconomics (11) (1) (2011), (Topics), Article 41

Uribe, Martin, and Yue, Vivian Z., "Country spreads and emerging economies: Who drives whom?" Journal of International Economics (69)(1) (2006); pp. 6-36

World Bank Database, http://data.worldbank.org/indicator/FR.INR.RINR (2012)

World Bank Database, http://data.worldbank.org/indicator/NE.CON.GOVT.ZS (2013)