Revisiting the growth effects of fiscal policy: A Bayesian model averaging approach

Abstract

Motivated by the mixed evidence in previous literature, we re-examine the effects of various types of government spending, taxes, and 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, 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 in the short to medium run. 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. Finally, our results suggest that a cyclically adjusted budget surplus has a robust positive effect on economic performance. Some, but limited, evidence points to effects of productive expenditure and of top income tax rates on medium-to-long-run growth. With regard to timing of short-to-medium run effects, our results show that most effects occur with a lag of two years.