Graduate Institute of International and Development Studies Working Paper 08-2017
In this paper we estimate the effect of government consumption shocks on GDP using a panel of 21 developing economies. Our goal is to better understand the reasons for the low fiscal multipliers found in the literature by performing estimations for alternative exchange rate regimes, business-cycle phases, and monetary policy stances. In addition, we perform counterfactual simulations to analyze the possible gains from fiscal-monetary policy coordination. The results imply that government consumption shocks are usually followed by monetary policy tightening in developing economies with flexible regimes. Our simulations show that this reaction partially explains the presence of low fiscal multipliers in these economies. On the other hand, we find that government consumption shocks have better multipliers in developing economies during fixed regimes, economic booms and monetary expansions. In particular, implementing fiscal programs during monetary expansions seems to improve significantly their economic stimulus.