trade shocks.

Brueckner and Gradstein (2013) examine the impact that rainfall volatility has on GDP volatility and government size. They find that rainfall volatility has a significant effect on GDP volatility in developing countries. Using rainfall volatility as an instrument for GDP volatility they find that the latter variable has a significant positive effect on government size.

# **Government Spending Cyclicality**

Government spending can mitigate the negative effect that volatility has on growth if: (i) government spending is counter-cyclical; and (ii) its impact on output is positive. For conceptual clarity it is useful to note that: (i) refers to the behavior of government spending, i.e. the response of government spending to the business-cycle; (ii) refers to the government spending multiplier, i.e. the effectiveness of government spending with regard to changing output in the short-run (and possibly the long-run). If government spending is pro-cyclical and the government spending multiplier is positive, then increases in the variance of exogenous shocks will have a more negative effect on growth.

The mainstream result in the empirical literature on government spending cyclicality is that government spending tends to pro-cyclical in (the majority of) developing countries. Telvi and Vegh (2002) find that fiscal policy is acylical in G7 countries while it is procyclical in developing countries. Their findings are based on a sample of 56 countries during the period 1970-1994. Based on a sample of 104 countries for the period 1960-2003, Kaminsky et al. (2005) find that in OECD countries government spending is counter-cyclical while it is procyclical in developing countries. Using instrumental variables estimation, Brueckner and Gradstein (2014) show that in developing countries government spending responds strongly to persistent variation in GDP; the response of government spending to transitory variation in GDP is positive but not significantly different from zero. These authors show that transitory output shocks have a smaller effect on government spending than persistent shocks.

A strand of the literature has argued that the cyclicality of government spending depends on financial market imperfections. In particular, financing constraints prevent governments from borrowing during recessions; see Gavin and Perotti (1997). The presence of financing constraints suggests asymmetry in the response of government spending to the business cycle. Hercowitz and Strawczynski (2004) provide empirical evidence for a ratcheting effect. These authors document that in OECD countries the ratio of government spending over GDP rises during recessions and is only partially reduced during booms.

A more recent strand of the literature has argued that the cyclicality of government spending depends on institutions. Alesina et al. (2008) argue that the pro-cyclicality of government spending is related to corruption. Based on a sample of 83 countries during 1960-2003, they find that in democracies with higher levels of corruption government spending is more procyclical. The authors explain their finding through the lens of a political economy model where voters “starve the Leviathan” in order to reduce political rents. During a boom, voters demand more public goods and lower taxes in order to prevent corrupt politicians from appropriating tax revenues.

The results in Alesina et al. (2008) are related to Lane (2003) who estimates the response of government spending to the output gap in OECD countries. Lane finds that government spending is procyclical in OECD countries with dispersed political power.

Frankel et al. (2013) examine the response of government spending to the output gap for a 7