Government Size and Business Cycle Volatility; How Important Are Credit Constraints?

In this paper we analyze how the availability of credit in uences the relationship between government size as a proxy for scal stabilization policy and the amplitude of business cycle uctuations in a sample of advanced OECD countries. Interpreting relatively low loan-tovalue ratios as an indication for tight credit constraints, we nd that government size exerts a stabilizing eect on output and consumption growth uctuations only when credit constraints are relatively tight. Our results are robust with respect to dierent measures of government size and provide support for the hypothesis that credit market frictions play a crucial role in the transmission of scal policy.