Fiscal space and the procyclicality of fiscal policy: the case for making hay while the sun shines

Utilizing data from 133 countries over the period 1950-2014, we identify fiscal space - the ability to pursue active fiscal policy without undermining fiscal sustainability - as a key factor underlying the cyclicality of fiscal policies. We find that less fiscal space induces greater fiscal procyclicality; and the reduction in fiscal space in high income countries in the post-global financial crisis period prevented these economies from adopting countercyclical fiscal policies. We also show that this relationship is non-linear such that countries in the bottom tail of the fiscal space distribution need to make significant improvements before they are able to perform countercyclical policy. Taken together with the increasingly dominant role of fiscal action in downturns, as is highlighted in the context of the responses to the Covid-19 crisis, these findings clearly indicate the importance of building fiscal space in good times to provide capacity for countercyclical policy in bad times.