Do good institutions promote counter-cyclical macroeconomic policies?

The literature has argued that developing countries are unable to adopt counter-cyclical monetary and fiscal policies due to financial imperfections and unfavorable politicaleconomy conditions. Using a world sample of 115 industrial and developing countries for 1984-2008, we find that the level of institutional quality plays a key role in countries' ability to implement counter-cyclical macroeconomic policies. The results show that countries with strong (weak) institutions adopt counter- (pro-) cyclical macroeconomic policies, reflected in extended monetary policy and fiscal policy rules. The threshold level of institutional quality at which monetary and fiscal policies are a-cyclical is found to be similar.