Economic growth before and after the fiscal stimulus of 2008–2009: the role of institutional quality and government size

Governments implemented fiscal stimulus packages to alleviate the global financial crisis of 2007–2009. Using annual data from 1996 to 2019, we investigate economic growth in a large sample of countries for pre-and post-Global Financial Crisis years. Our approach analyzes the interaction between institutional quality and government size (government expenditures as share of GDP), reinforced by threshold estimations. We document that economies react to government size depending on the quality of the institutions in question. First, fixed effects models indicate higher institutional quality has positive effects on growth, while government size—and its interactions with institutional quality—has negative effects. Second, the coefficients of government size on economic growth are negative with higher institutional quality and become larger in the post-Global Financial Crisis years. These combined results indicate that higher-quality institutions make economies less tolerant of rising government expenditures than lower-quality institutions. Our main findings support institutional quality as the channel through which fiscal policy has real effects. The evidence herein is robust to measures of institutional quality from different databases.