Government spending dynamics in small open economies

Raphaelle G. Coulombe and Jaroslav Horvath

Journal of International Money and Finance, 2026, vol. 161, issue C

Abstract: Compared to small open advanced economies (AEs), emerging market economies (EMEs) exhibit simultaneously higher volatility and procyclicality of government spending, two features likely to amplify business cycle fluctuations. To rationalize these stylized facts, we augment the canonical small open economy model with heterogeneous parties and repeated elections with endogenous voting. We relate the distinct dynamics of government spending in EMEs to a combination of larger interest rate fluctuations and a higher degree of political polarization. While, on their own, interest rate shocks and political polarization account, respectively, for about a quarter and a half of government spending variance in EMEs, we show that higher political polarization amplifies the macroeconomic effects of interest rate shocks by increasing political turnover. We provide corroborating evidence for this mechanism by documenting that EMEs exhibit, on average, larger political turnover than AEs.

Keywords: Government spending; Interest rate shocks; Polarization; Emerging economies (search for similar items in EconPapers)
JEL-codes: E62 F41 F44 (search for similar items in EconPapers)
Date: 2026
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:161:y:2026:i:c:s0261560625002189

DOI: 10.1016/j.jimonfin.2025.103483

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