Macroeconomic Consequences of Volatile Discretionary Fiscal Policy: Evidence from Developing Countries

Abstract

This study aims to investigate the macroeconomic implications of discretionary spending volatility. The study considers a panel of developing economies, including 55 economies – 25 upper- and 30 lower-middle-income countries. The study utilizes panel data that cover a period from 2000-2021. The study estimates the discretionary public spending through a fiscal rule and its volatility via the years moving average standard deviation method. To estimate the impact of discretionary spending volatility on economic growth and private investment, this study employs the Generalized Method of Moment (GMM) estimation technique. The estimation results for the aggregated panel show that volatility in discretionary public spending adversely affects economic growth and private investment. Interestingly, the estimation results confirm that aggregated findings remain intact for the disaggregated panels, i.e., volatility in discretionary public spending adversely affects economic growth and private investment in upper and lower middle-income countries. However, volatility in discretionary public spending has a relatively high negative impact on economic growth and private investment in lower-middle-income countries. It suggests that fiscal rules (i.e., permanent numerical limits on total government expenditure) should be introduced to restrict government from the volatile use of discretionary policy.