Exploring the Output Effect of Fiscal Policy Shocks in Low Income Countries

IMF Working Papers, January 17, 2020

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Canonical URL: Exploring the Output Effect of Fiscal Policy Shocks in Low Income Countries

Research question: What are the output effects of fiscal policy (government spending shocks) in low income countries (LICs)?
Method: Analysis based on the local projection method.

The output effects in LICs are markedly lower than those in AEs.
The output effects in LICs are marginally smaller than those in EMs.
In LICs, output effects are larger under the following conditions:
- during recessions;
- under a fixed exchange rate regime;
- with higher quality of institutions.
The analysis could not confirm any statistically significant output effect under floating exchange rate regimes.
Implication: For estimation of output effects of fiscal spending shocks, it is important to consider the state of the economy and the country’s structural characteristics.

The output costs of fiscal adjustment in LICs may not be as large as previously thought, especially if:
- adopted outside of a recession;
- based on cutting public consumption;
- accompanied by reform to enhance institutions.
Fiscal policy design in LICs should account for:
- cyclical position (recession versus non-recession);
- exchange rate regime (fixed versus floating);
- institutional quality.

Subject: Exchange rate arrangements, Expenditure, Fiscal multipliers, Fiscal policy, Floating exchange rates, Foreign exchange
Keywords: countercyclical fiscal policy, Exchange rate arrangements, Fiscal multipliers, Fiscal Policy, fiscal policy shock, Floating exchange rates, government spending shock, LIC economy, Low Income Countries, output effect, Sub-Saharan Africa, WP

Source: IMF Working Paper "Exploring the Output Effect of Fiscal Policy Shocks in Low Income Countries" (January 17, 2020).