Exploring Budget Deficit Volatility in Developing Countries: An Economic and Institutional Analysis

Abstract

This study provides an analysis of the budget deficit Volatility of a panel of 41 developing countries, which consists of 24 Asian developing countries and 17 Latin American countries. It examines the budget deficit's economic and institutional determinants, including per capita GDP, budget deficit, trade openness, inflation, unemployment, and institutional quality measures. The study utilizes the Pedroni Panel Cointegration technique and the Fully Modified Ordinary Least Squares (FMOLS) to estimate the budget deficit volatility of developing countries from 1991 to 2020. The findings of the study reveal that although institutional quality is an essential component in reducing budget deficit volatility, the coefficient of institutional quality is quantitatively more significant for Asian countries as compared to Latin American countries. Furthermore, the budget deficit, per capita GDP inflation rate, and trade openness have been proven to significantly and positively affect the budget deficit volatility in the case of both regions. A country’s population negatively affects budget deficit volatility implies that population growth leads to more volatility. Results of the overall sample of 41 developing countries are pretty similar to the findings of each of the two regions except for the real per capita GDP, which appears statistically insignificant. The study recommends that budget deficit volatility can be stabilized in developing countries by improving institutional quality and price stability.