We study the cyclical behavior of fiscal policy to explain why some countries exhibit procyclical fiscal policy stances—being expansionary in good times and contractionary in bad times. We develop a model that links the polarization of preferences over fiscal spending to the procyclicality bias. We then present evidence that social polarization as measured by income inequality and educational inequality is consistently and positively associated with fiscal procyclicality, even after controlling for other determinants from existing theories. We also find a strong negative impact of fiscal procyclicality on economic growth.

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Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology
2009
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