Procyclical Fiscal Policy and Asset Market Incompleteness

Andrés Fernández Martin, Daniel Guzman Giron (), Ruy Lama and Carlos Vegh

No 29149, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: To explain the fact that government spending and tax policy are procyclical in emerging and developing countries, we develop a model for the joint behavior of optimal tax rates and government spending over the business cycle. Our set-up relies on financial frictions, which have been shown to be critical features of emerging markets, captured by various degrees of asset market incompleteness as well as varying levels of debt-elastic interest rate spreads. We first uncover a novel theoretical result within a simple static framework: incomplete markets can account for procyclical government spending but not necessarily procyclical tax policy. Explaining procyclical tax policy also requires that the ratio of private to public consumption comoves positively with the business cycle, which leads to larger fluctuations in the tax base. We then show that the procyclicality of tax policy holds in a more realistic DSGE model calibrated to emerging markets. Finally, we illustrate how larger financial frictions, which amplify the business cycle through more procyclical fiscal policies, have sizeable Lucas-type welfare costs.

JEL-codes: F41 F44 H21 H30 (search for similar items in EconPapers)
Date: 2021-08
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-fdg, nep-isf, nep-mac, nep-opm and nep-pbe
Note: IFM
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.nber.org/papers/w29149.pdf (application/pdf)

Related works:
Working Paper: Procyclical fiscal policy and asset market incompleteness (2021)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:29149

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w29149

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().