Cyclical Budgetary Policy and Economic Growth: What Do We Learn from OECD Panel Data?

This paper uses yearly panel data on OECD countries to analyze the relationship between growth and the cyclicality of the budget deficit. We develop new yearly estimates of the countercyclicality of the budget deficit and show that the budget deficit has become increasingly countercyclical in most OECD countries over the past twenty years. However, European Monetary Union (EMU) countries did not become more countercyclical. Using panel specifications with country- and year-fixed effects, we show that: (a) an increase in financial development, a decrease in openness to trade, and the adoption of an inflation-targeting regime move countries toward a more countercyclical budget deficit; (b) a more countercyclical budget deficit has a positive and significant effect on economic growth, and this effect is larger when financial development is lower.