Fiscal Policy, Government Ideology, and Economic Activity: Evidence from OECD Countries

Abstract

This study explores the role played by a country's political environment in the origin and effect of government spending. Using a rich data set that contains time-varying ideological party positions, I show that both government ideology and the timing of elections are key determinants of government spending shocks and Granger-cause government spending shocks estimated from traditional structural vector autoregressive (SVAR) models that ignore political considerations. I find that the magnitude of the spending multiplier depends on the political context: highly polarized countries have smaller multipliers relative to countries with a low degree of polarization, and established democracies have smaller multipliers than younger democracies.