dynamics and sources of volatility in developing countries, but does not seem to play an important role in developed economies.

Lastly, we investigate how volatility sources differ by institutional quality and the presence of fiscal rules. When conditioning the sources of GDP volatility on whether or not a country has adopted fiscal rule(s), we find that shocks to GDP and government expenditures are responsible for a larger share of GDP volatility in fiscal rule(s) non-adopters. On the other hand, shocks to the world demand conditions and trade balance play a greater role for GDP volatility in fiscal adopters.

As for the measure of institutional development, we find that it is highly correlated with the measure of economic development in our sample of countries as both variance decompositions and impulse responses in countries with high quality of institutions are almost identical to those in developed economies, while the results in countries with low quality of institutions are symmetric to our findings obtained for developing economies. These results therefore are rendered to the appendix.

Overall, our results indicate that sources of volatility differ systematically by country size (especially for the developing countries group), by the level of development, and by whether or not a country has adopted fiscal rule(s). Our results also suggest a few directions for fiscal policy in small countries. In particular, given greater susceptibility of small countries to terms of trade shocks and shocks to domestic GDP, a countercyclical fiscal policy and fiscal policy rules that encourage accumulation of precautionary fiscal savings would help cushion the effects of these shocks on the economy and thus lower GDP volatility in these countries.

The rest of the paper is structured as follows. Section 2 provides the description of our data set, while Section 3 contains the literature overview and methodology. The results from countryby-country and panel VARs are summarized in Section 4. Section 5 discusses policy implications of our findings. Section 6 concludes.

# **2. Data Description**

Our data come from several sources. To capture country size, we use population. These data are taken from the _World Development Indicators_ (WDI) database of the World Bank and cover the period of 1960-2015 at annual frequency.

Most macroeconomic variables such as GDP, government expenditures, trade balance, current account, CPI, terms of trade, real exchange rate, and various interest rates are from the International Financial Statistics (IFS) database by the International Monetary Fund. The data cover the period of 1960-2015. For many developing countries, the IFS data are either incomplete, or not available altogether. In addition, as was highlighted in the literature (see, for instance, Ilzetzki et al. 2013), quarterly data for many developing countries could be problematic because it is often i nterpolated from annual data, rather than originally collected at the quarterly frequency. We try to address this issue by supplementing and/or replacing IFS data using the series collected from national data sources, such as National Central Banks or National Statistical Agencies.

The macroeconomic quantities in our data set are measured in current local currency units. To transform the data into real terms, all nominal quantities are deflated by the CPI deflator. Nominal 4