Fiscal Reaction Function and Macroeconomic Shocks: Evidence from Developing Countries

This study investigates the fiscal reaction functions of 142 developing countries over the period 2000–2024 using a Panel Structural Vector Autoregression (PSVAR) framework. It examines how fiscal policy responds to public debt and a range of macroeconomic shocks. The results indicate that the primary fiscal balance generally increases in response to rising public debt, reflecting a countercyclical effort to preserve debt sustainability. In contrast, fiscal policy tends to exhibit procyclical behavior in response to positive commodity price and output shocks, while responding countercyclically to inflation and interest rate shocks. These patterns suggest that, although many countries adjust their fiscal stance to rising debt, the scale and timing of such adjustments vary considerably, driven by country-specific institutional and economic conditions. Evidence of fiscal fatigue at elevated debt levels highlights the danger of persistent deficits, where delayed or insufficient adjustments erode fiscal space and threaten long-term sustainability. The findings underscore the need for credible, well-designed fiscal rules that combine flexibility to accommodate economic cycles with sufficient rigor to maintain fiscal discipline. Jel: E10 E62 H63