Getting it Right: How Fiscal Response Can Shorten Crisis Length and Raise Growth

Abstract

The authors use an ordered logit model to assess the effects of fiscal stimulus packages during episodes of systemic banking crisis in advanced and emerging market countries over the period 1980-2008. The results show that timely countercyclical fiscal measures can help shorten crises by boosting aggregate demand and offsetting the collapse of private investments. Nevertheless, these outcomes are weaker for countries with limited budgetary room and where fiscal expansion is prevented by funding constraints or limited access to markets. The composition of fiscal responses is important: fiscal expansions based on government consumption and income tax cut are more effective in shortening the recession, while a larger share of public investment yields the strongest impact on output growth. These findings suggest a potential trade off between short-run aggregate demand support and medium-term productivity growth objectives. Two stylised facts emerge: i) the fiscal measures enacted by G-20 countries may have curtailed the crisis by up to one year and ii) they may have stimulated post-crisis growth by 1 per cent of GDP compared with the counterfactual scenario of no fiscal stimulus. Results can be larger for emerging market economies than for advanced countries, since the former devoted a greater share of the stimulus to infrastructure, while the latter made greater resort to tax cuts and transfer increases.