American Economic Journal:
Macroeconomics
ISSN 1945-7707 (Print) | ISSN 1945-7715 (Online)
Procyclical Fiscal Policy and Asset Market Incompleteness
American Economic Journal: Macroeconomics
(pp. 228–70)
Abstract
We develop a model of the joint behavior of optimal tax rates and government spending over the business cycle to explain procyclical fiscal policy in emerging markets. Our setup relies on financial frictions, which have been shown to be critical features of emerging markets, captured by various degrees of asset market incompleteness as well as varying levels of debt-elastic interest rate spreads. We show that incomplete markets can account for procyclical government spending but not necessarily procyclical tax policy. Explaining procyclical tax policy also requires that the ratio of private to public consumption comoves positively with the business cycle.Citation
Fernández, Andrés, Daniel Guzmán-Girón, Ruy Lama, and Carlos Vegh. 2026. "Procyclical Fiscal Policy and Asset Market Incompleteness." American Economic Journal: Macroeconomics 18 (4): 228–70. DOI: 10.1257/mac.20220304Additional Materials
JEL Classification
- E12 General Aggregative Models: Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
- E21 Macroeconomics: Consumption; Saving; Wealth
- E31 Price Level; Inflation; Deflation
- E32 Business Fluctuations; Cycles
- E43 Interest Rates: Determination, Term Structure, and Effects
- E62 Fiscal Policy
- H50 National Government Expenditures and Related Policies: General