Can Fiscal Decentralization Alleviate Government Consumption Volatility?

Abstract

This paper assesses the effect of fiscal decentralization on government consumption volatility using data for 97 developed and developing countries from 1971 to 2010. The results suggest that a higher degree of fiscal decentralization leads to lower government consumption volatility. This result holds for the sub-sample of advanced economies, while it is not confirmed for those less-developed. This mechanism seems to work mainly through a lower volatility of the non-discretionary spending, which typically belongs to the central government’s policy. We also confirm existing findings according to which country size lowers government spending volatility. Thus, given a minimum level of development, fiscal decentralization reforms can reduce spending volatility by distributing power to sub-central governments, particularly in smaller countries which are usually more prone to volatility.