Terrorism and Fiscal Policy Volatility in Developing Countries: Evidence from cross-country and Panel Data

Abstract : This paper investigates the effect of terrorism on fiscal policy volatility in developing countries. Using both cross-country and panel data analysis for 66 countries from 1970 to 2012, we find that an increase in the number of terrorist incidents raise the volatility of the discretionary component of fiscal policy. In addition, the analysis shows that fiscal volatility is positively influenced by the volatility of output growth, the consumer price inflation volatility, the degree of fractionalization of both the government and the opposition. The results also show that the volatility is higher is countries of small size and lower in more democratic countries. Our results are robust to reverse causality, endogeneity bias and the presence of various controls. This paper complements and extends the previous literature by providing the evidence that terrorism substantially increases the uncertainty surrounding the conduct of fiscal policy in developing countries.