set of 93 countries during 1960-2009. These authors find that country-specific coefficients characterizing the response of government spending to the output gap are negative for industrialized countries while in emerging market and developing countries these coefficients are positive, thus indicating procyclicality. Frankel et al. show that the country-specific government spending cyclicality coefficients are negatively correlated with measures of institutional quality.<sup>4</sup> Carneiro and Garrido (2015) document that the findings in Frankel et al. are robust to expanding the sample to 180 countries during 1980–2012. Further, Carneiro and Garrido document that the findings in Frankel et al. are robust to using different filtering methods and allowing for structural breaks.

There is no consensus in the literature regarding the size of the government spending multiplier in developed countries. Keynesians argue for government spending multipliers that exceed unity while neoclassical economists argue that government spending multipliers are small, i.e. below unity and possibly negative. See Ramey for a review (2011). Ramey and Zubairy (2014) find that there is no evidence that the government spending multiplier is state-dependent, i.e. they find no evidence that the government spending multiplier is larger during recessions or when monetary policy is at the zero lower bound.

The literature on the government spending multiplier in developing countries is not as developed as the literature for industrialized countries. Evidence based on instrumental variables regressions suggests that the government spending multiplier in developing countries is positive but below unity, see Kraay (2012, 2014). Kraay (2012) instruments government spending in developing countries with World Bank project-level disbursements. These disbursements, Kraay argues, are exogenous because they isolate the component of World Bank-financed government spending in a given year that is associated with past project approval decisions. For a sample of 29 primarily lowincome countries where variation in government spending from this source is large relative to the size of the economy, Kraay finds that the government spending multiplier is around 0.5, thus positive but below zero. Extending the sample to 102 developing countries over the period 19702010, Kraay (2014) finds that the one-year spending multiplier is around 0.4

# **Financial Development**

Aghion et al. (2010) study how credit constraints affect the impact that volatility has on economic growth. They develop a model where firms have the option to engage in short-term investment projects and long-term investment projects. Long-term investment projects differ from short-term investment projects in two important aspects: (i) long-term investment projects are characterized by a relatively less volatile long-term return; (ii) long-term investment projects have a high liquidity risk. In the absence of financial frictions, i.e. when markets are perfect, long-term investment is counter-cyclical (the cost of long-term investment is lower in recessions). When firms are faced with financing frictions, the higher liquidity risk associated with long-term investment implies that firms may only be able to start long-term investment projects during booms; i.e. financing frictions imply that long-term investment may be counter-cyclical.

A testable prediction of the Aghion et al. (2010) model is that in countries with underdeveloped financial markets, volatility has a more negative effect on growth. The mechanism in the Aghion et al. (2010) model is through a lower share of long-term investment projects (that have a more positive effect on productivity). For a panel of 21 OECD countries during 1960-2000, the authors examine the effect of commodity price volatility on economic growth. Long-term investment projects are measured by the ratio of structural investment to total private investment.

> 4  The index of institutional quality that is used in Frankel et al. is based on data provided by International Country Risk Guide on the investment profile, corruption, the rule of law, and bureaucratic quality.

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