Revisiting the Growth Effects of Fiscal Policy: A Bayesian Model Averaging Approach

Abstract

Motivated by the mixed evidence in previous literature, we reexamine the effects of various types of government spending and taxes, as well as overall budget surplus/deficit, on economic growth. To address the model uncertainty issue that may have plagued earlier studies we employ a Bayesian Model Averaging (BMA) approach. We use a panel data set for OECD countries for the 1990-2013 period, control for country and time specific effects, and allow for a wide range of other potential growth determinants. The results suggest a robust link between only some fiscal variables and economic growth. On the spending side, productive public spending has a robust positive effect on growth. On the revenue side, we document a robust negative effect for the top corporate tax rate, but, maybe surprisingly, not for any income tax variable. Finally, our results suggest that a budget surplus has a robust positive effect on economic performance. We also analyze the timing of effects and conclude that most effects occur with a lag of two years.

Keywords: Fiscal Policy, Public Spending, Taxes, Economic Growth

JEL Classification: E62, H20, O40