Fiscal spending and growth: More patterns

by Céline Carrère and Jaime de Melo

Vox
May 17, 2012

It is not just the OECD countries where fiscal policy is the subject of fierce debate. This column presents results from an “event analysis” carried out on a database of 140 countries over the period 1972-2005. It suggests that, for developing countries at least, a fiscal stimulus can be effective – provided the rest of the economy is stable and the fiscal deficit is low.

As the Eurozone is entering into recession, fiscal policy has moved to centre stage. The extent of austerity has been widely attacked, including by IMF staff (Cottarelli 2012), while the design of fiscal policy, namely expenditure reductions versus tax increases (Alesina and Giavazzi 2012), has also come under scrutiny. Reflecting the growing intensity of this debate, Vox launched a debate to move closer to a consensus on the circumstances under which governments should relent on their efforts to reduce a fiscal deficit when policy credibility is still far from granted (Corsetti and Müller 2012).

This column summarises results from our recent study focusing on identifying links between “substantial” changes in government expenditures and “growth accelerations” (Carrère and de Melo 2012). We use event analysis, i.e. we reorganise the data around the event of interest – here a sizeable and sustained change in fiscal expenditures. In a large sample of countries where growth instability is pervasive, this approach helps unveil any relation between fiscal expenditures and growth. The focus is on identifying if developing countries have “fiscal space” for discretionary fiscal expenditures, but a cautious interpretation of the results should be informative in a broader context.

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