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Impacts of fiscal policy on economic growth: Another look from institutional perspective

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  • Ho Thuy Ai
  • Ping, Lin

Abstract

What is the role of economic institutions in the effectiveness of fiscal policy? This paper argues that the extent to which fiscal policy affects long-term growth depends on how economically free a country enjoys. The authors use a sample of 72 countries over the period 1990 through 2015 to provide empirical evidence on the interrelationship between government spending, economic freedom and economic growth. The non-linear effect of fiscal policy on growth is investigated by extending the classical growth regression with an interaction term between fiscal policy and economic freedom. The results suggest that it is economic freedom that determines the effect of fiscal policy on economic growth. Public investment in infrastructure can enhance long-term growth better in countries with less degree of freedom. Meanwhile, public consumption does not benefit growth but its adverse impact is mitigated if a country is more economically free. The authors also find that the determining role of institutions in emerging countries is more prominent than that in advanced economies which are pretty homogenous in economic development and have already been at a high level of economic freedom.

Suggested Citation

  • Ho Thuy Ai & Ping, Lin, 2018. "Impacts of fiscal policy on economic growth: Another look from institutional perspective," Economics Discussion Papers 2018-45, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:201845
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    Keywords

    fiscal policy; government expenditure; institutions; economic freedom; economic growth;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth

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