The cyclicality of fiscal policy: New evidence from unobserved components approach

This paper employs the multivariate version of the unobserved components model to reinvestigate the cyclicality of fiscal policy in eleven OECD countries. The novelty of the multivariate approach lies in its superior ability to disentangle the correlations in cycles from the correlations in slopes of the relevant variables while allowing for those correlations in the model. The results suggest that fiscal policy is mildly counter-cyclical in seven of the eleven countries analyzed which resonates with the standard Keynesian models. However, the slope (growth) of government consumption is found to be positively correlated with real GDP in these economies. There is no evidence of procyclical fiscal policies in any of these eleven industrial countries. The results remain robust when we use subsamples and an alternative fiscal policy variable.