The Nexus between Fiscal Policy Volatility and Business Cycle Fluctuations: Evidence from South Asian Economies

Abstract

Volatility in fiscal policy has diverse macroeconomics implications. This study examines the impact of government spending volatility on output volatility in case of South Asian economies. The study utilizes panel data of four South Asian economies over the period of 1980 to 2022 and employs Generalized Method of Moment (GMM) estimation technique. The findings depict that volatility in fiscal spending minimizes volatility in the output, i.e., it mitigates fluctuations in the business cycle and leads to macroeconomic stability. The magnitude of the coefficient associated with government spending volatility suggests that a one standard deviation increase in spending volatility dampens output volatility by 0.53 standard deviation. Although, volatility in fiscal spending stabilizes business cycle fluctuations; however, it is important to prudently exercise such volatility, because if it is exercised independent of business cycle it might be a potential source of macroeconomic instability. For this purpose, a flexible, but fiscal rule-based policies should be designed that help to minimize macroeconomic fluctuations and also to avoid over aggressive utilization of public spending that may undermine economic growth.

JEL Classification: E62, E32, C30, O53