Democracy, institutional quality and fiscal policy cycle: evidence from developing countries

Economists usually prescribe countercyclical fiscal policies to stabilize economies: government spending should increase during economic downturns and decrease during booms. Yet, empirical research has documented procyclical fiscal policy in several democratic developing countries. Using an updated dataset of 63 developing countries from 1980 to 2013, this article robustly shows procyclical fiscal policy in democratic and non-democratic developing countries. The essence of this paper is controlling endogeneity issues by using the generalized method of moment (GMM) for the dynamic panel data model and investigating the interaction between democracy and the quality of democratic institutions in affecting the fiscal policy cycle. This article finds that an improvement in the quality of institutions plays a vital role in restraining procyclical fiscal policy and these effects are more prominent in democratic countries than non-democratic ones.