1. Introduction

1. Introduction1

Aggregate demand management is an important role of fiscal policy2. An effective fiscal policy smooths aggregate consumption over the ups and downs of the business cycle. That is, fiscal expenditures would rise in recessions and fall (or at least not rise as much) during boom times. The macro literature refers to this phenomenon as countercyclical fiscal expenditures. Thus, a useful metric for determining the effectiveness of fiscal policy’s demand management role is the cyclicality of fiscal expenditures, which refers to how responsive fiscal expenditures are to the business cycle. Rising fiscal expenditures in recessions can help the population cope with falling private income and can stimulate the economy, especially since fiscal multipliers tend to be larger in bad times. In other words, a $1 of government expenditure can generate more output in bad times than it does in good times (see Corsetti et al., 2012; Riera-Crichton et al., 2015; Auerbach and Gorodnichenko, 2012). Therefore, government spending is more powerful in stimulating the economy in bad times. Conversely, fiscal expenditure should be contained in boom times so as not to overheat the economy and to accumulate savings for a “rainy day.” Empirically, fiscal countercyclicality has been found to help growth (Woo, 2009).

Countercyclical fiscal expenditure policy is not easy to implement. Several factors can prevent governments from implementing countercyclical fiscal policies. Governments tend to be overly optimistic about their growth prospects (see for example Gatti et al., 2022), often treating temporary booms as permanent shifts. Therefore, governments may enact permanent spending programs based on temporary revenue windfalls (Vegh, Lederman, and Bennet, 2017). Political pressures from interest groups may force governments to spend more in good times (see Tornell and Lane, 1999 and Lane, 2003). In corrupt democracies, voters demand more public goods in good times to reduce potential political rents for corrupt politicians, leading to procyclical fiscal policy (Alesina et al., 2008). Income inequality also plays a role. Woo (2009) find that less equal countries run more procyclical fiscal policy, because heterogenous policymakers may have stronger incentives to pursue their preferred agendas, particularly in good times when resources are available. Finally, in bad times, governments may be unable to expand spending because of lack of access to affordable finance (Gavin and Perotti, 1997). They might even have to pay higher interest rates or cannot roll over their debt (forced to pay) in bad times. Empirically, Kaminsky et al. (2004) show that fiscal policy was procyclical for many developing countries, although some have become more countercyclical in recent years (Frankel et al., 2013).

This chapter examines the cyclicality of fiscal expenditure, focusing on Middle East and North Africa countries (Part II). It then examines how accountability can play a role in the cyclicality of fiscal expenditures (Part III). An important distinction is between the cylicality of fiscal expenditures in good versus in bad times, which will be investigated in this chapter. In bad times, fiscal expansion is argued to depend more on the population’s needs and on access to finance (Riascos and Végh, 2003), whereas in good times, fiscal cyclicality probably depends more on the checks and balances that help rein in fiscal spending.

This chapter reports three findings. First, fiscal expenditures in the Middle East and North Africa remained procyclical between 2000 and 2020, although it became less so than from 1980 to 1999. The Middle East and North Africa has been more procyclical than income peers in fiscal expenditures in the last two decades. Second, accountability of the government’s executive branch matters in the cyclicality of government expenditures. The chapter considers three measures of accountability from the V-DEM Institute’s Varieties of Democracy Dataset, discussed in Luhrmann et al.

1 The authors are grateful to Roberta Gatti, Daniel Lederman, Kevin Carey and Hoda Assem for detailed comments and feedback. 2 Another important role of fiscal expenditures is their structural role. With investment in health, education and infrastructure, fiscal expenditures can enhance long-term productivity of the economy.