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How Large is the Government Spending Multiplier? Evidence from World Bank Lending

On Monday, November 1, 2010 The Center for Global Development and The Paul H. Nitze School of Advanced International Studies hosted a Massachusetts Avenue Development Seminar (MADS)* entitled How Large is the Government Spending Multiplier? Evidence from World Bank Lending. The seminar featured Aart Kraay, Lead Economist in the Development Research Group at the World Bank. Antonio Spilimbergo of the International Monetary Fund served as the disscusant.

Access paper here.

Abstract: In this paper I propose a novel approach to isolating exogenous fluctuations in public spending in order to estimate government spending multipliers in low-income countries. My approach relies on two features unique to many low-income countries: (1) borrowing from the World Bank finances a substantial fraction of public spending, and (2) actual disbursements on World Bank loans are typically spread out over several years following the original approval of the loan. These two features imply that fluctuations in disbursements on World Bank loans, and the significant portion of public spending they finance, are in large part determined by fluctuations in loan approval decisions made in previous years, and so are unlikely to be correlated with shocks to output in the current year. I use project-level data on disbursements on World Bank loans to isolate this predetermined component of public spending and use it to estimate government spending multipliers in a sample of 48 aid-dependent low-income countries. The multipliers I obtain are small and surprisingly precisely estimated, ranging from 0 to 0.3 on impact, and at most slightly larger in the long run. These results suggest that countercyclical fiscal stimulus spending is unlikely to be an effective stabilization tool in these countries.

*The Massachusetts Avenue Development Seminar (MADS) is a ten year-old research seminar series that brings some of the world's leading development scholars to discuss their new research and ideas. The presentations meet an academic standard of quality and are at times technical, but retain a focus on a mixed audience of researchers and policymakers.


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