The effectiveness of fiscal policy: contributions from institutions and external debts

Abstract

The effectiveness of fiscal policy is an interesting field in literature of macroeconomics. In this paper, we use panel data from 2002 to 2014 from 20 emerging markets to investigate the effects of fiscal policy on economic growth under contributions from the differences in institutions and external debt levels. By using GMM estimators for unbalanced panel data, our results show positive effects of fiscal policy on economic growth across emerging markets in the examined periods. Notably, the improvement in institutions promotes higher crowding-in effects of fiscal policy. In addition, this paper finds interesting evidences that the external debt has non-linear effects on economic growth, whereas the heterogeneous effects of fiscal policy on economic growth as positive effects in low indebted level and negative effect in high indebted level may explain the mechanism of this non-linear relationship. The results have significant contributions to the literature and useful implications for authorizers in promoting sustainability of the economy. The authorizers are strongly recommended to focus on improving the institutional quality that not only boosts the effectiveness of fiscal policy in general, but also solves the dilemma of high indebted countries when the fiscal policy loses the effectiveness.