Abstract:
This study investigates the relationship between macroeconomic volatility and growth in presence of credit constraints and governmental fiscal policy stance. The Schumpeterian endogenous growth model (Aghion et al., 2005) allowing for governmental fiscal policy over business cycles is adopted. The Schumpeterian growth theory envisaged that credit market imperfections prevent firms from borrowing which resultantly effect long run investments and innovations. In such scenario, there is a need of government intervention, which further raises the question whether government should follow countercyclical or procyclical fiscal policy? Theoretical predictions emphasize the role of countercyclical fiscal policies in presence of credit market imperfections for dampening the negative effect of business cycle fluctuations (volatility) on economic growth. It is observed that countries facing weak financial development adopt pro-cyclical fiscal policies and developed economies have countercyclical fiscal policies. The study uses the panel of four South Asian countries Bangladesh, India, Pakistan and Sri Lanka during the period from 1981 to 2015. The empirical analysis involves three steps using FMOLS methodology: (a) the relationship between volatility and growth in presence of financial constraints. (b) relationship between growth and fiscal policy cyclicality is analysed, and (c) impact of fiscal policy cyclicality and volatility on growth in presence of credit constraints. The results of this study are consistent with the theoretical predictions in terms of developing countries.
