CYCLICALITY AND FISCAL MULTIPLIER PREDICTION ERRORS IN DEVELOPING COUNTRIES

Abstract

Whether or not a government employs discretionary fiscal policy, and for that matter, to what extent a government employs discretionary fiscal policy, depends crucially on the predicted fiscal multiplier. A high predicted fiscal multiplier would incentivize fiscal policy as a stabilization tool, because a given increase or decrease in GDP would supposedly require a comparatively small increase or decrease in spending or taxes (or both). By the same reasoning, a low predicted fiscal multiplier would disincentivize fiscal policy. Since the predicted fiscal multiplier affects government decision-making in such a simple way, the accuracy and precision of fiscal multiplier predictions is vital for the health of an economy. While fiscal multiplier prediction errors in developed countries have been studied relatively extensively, there is a dearth of research on fiscal multiplier prediction errors in developing countries. Moreover, the possibility for prediction error differences in different stages of the business cycle is a frontier of economic research. Therefore, this paper investigates whether the magnitude of fiscal multiplier prediction errors in developing countries differs in expansions and recessions.