Fiscal space and the procyclicality of fiscal policy: The case for making hay while the sun shines

Abstract

Utilizing data from 133 countries over the period 1950–2014, we identify fiscal space as a key factor underlying the cyclicality of fiscal policies. We find that less fiscal space induces greater fiscal procyclicality and show that this relationship is nonlinear; countries in the bottom tail of the fiscal space distribution need to make significant improvements before they can perform countercyclical policy. Given the increasingly dominant role of fiscal action in downturns, as is highlighted during the Covid-19 crisis, these findings clearly indicate the importance of building fiscal space in good times to provide capacity for countercyclical policy in bad times.