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Rent-Seeking Distortions and Fiscal Procyclicality

By Ethan Ilzetzki Y


Several empirical studies have found that government expenditures are procyclical in developing countries, unlike the countercyclical expenditures observed in highincome countries. We develop a dynamic political economy model to explain this phenomenon. In the model, governments provide public insurance to uninsured households, and Pareto-e ¢ cient 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 …scal procyclicality. We …nd that without the political friction, borrowing constraints and di¤erences in macroeconomic volatility cannot account for the di¤erences in …scal policy across countries in this setting

Topics: Fiscal Procyclicality, Fiscal Policy in Developing Countries, Political Distortions. JEL Codes, F41, E62, D72
Year: 2008
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