Institutions and Cyclical Properties of Macroeconomic Policies. Central Bank of Chile, Working Paper 285

Strong swings in business-cycle conditions in industrial and emerging market economies (EMEs) alike have renewed the debate on effectiveness of stabilization policies. Traditionally it has been argued that EMEs are unable to pursue counter-cyclical monetary and fiscal policies due to financial imperfections and unfavorable political-economy equilibriums. However, we claim that EMEs with institutional features similar to those of industrial countries may be able to conduct counter-cyclical policies. Using a sample of 20 EMEs and annual data for the 1990-2003 period, we find that the level of institutional quality plays a key role in the ability of these economies to conduct stabilizing macroeconomic policies. The results show that EMEs with strong institutions are able to implement counter-cyclical macroeconomic policies, reflected in extended monetary-policy (Taylor) and fiscal-policy rules. A fact that reinforces our conclusions is that the threshold level of institutional quality that renders neutral macroeconomic policies to the cycle is very similar for monetary and fiscal policies. In addition, fiscal-policy cyclicality is more sensitive to institutional quality than monetary-policy cyclicality