Fiscal Policy, Government Ideology, and Economic Activity: Evidence from OECD Countries

Abstract This study explores the role played by a country's political environment in the origin and effect of government spending. Using a rich data set that contains time‐varying ideological party positions, I show that both government ideology and the timing of elections are key determinants of government spending shocks and Granger‐cause government spending shocks estimated from traditional structural vector autoregressive (SVAR) models that ignore political considerations. I find that the magnitude of the spending multiplier depends on the political context: highly polarized countries have smaller multipliers relative to countries with a low degree of polarization, and established democracies have smaller multipliers than younger democracies.