Institutional quality and cyclicality of monetary and fiscal policies in SAARC countries

Abstract

Theoretically, government intervention in an economy should be counter-cyclical; however, practically, it has not been so in many countries, particularly in developing ones. To explain this gap between theory and practice, recent researchers have identified institutional quality as an influential factor, though their results might be susceptible to certain econometric biases. In this study, taking care of possible reasons for econometric biases, the impact of institutional quality on the cyclicality of macroeconomic policies in selected SAARC countries has been scrutinized by utilizing annual data for 1984-2015 and applying four different estimation methods.The findings of this research confirm previous results that institutional quality does matter for the cyclicality or counter-cyclicality of policy interventions. Its impact is more vivid in the case of monetary policy as the threshold level for monetary policy is less than that for fiscal policy.This result implies that the reform agenda to make policy intervention strictly counter-cyclical should include institutional factors as well.