Working Paper Details

Policy Volatility, Institutions and Economic Growth
Antonio Fatas and Ilian Mihov
INSEAD 2005/76/EPS

 Policy Volatility, Institutions and Economic Growth  

There is significant controversy among academics and policy-makers about whether policies matter for economic growth. Recently, Acemoglu et al. (2003) and Easterly (2004) have presented empirical evidence against the commonly held view that policies play an important role in the process of economic development. Their key conclusion is that macroeconomic policies (monetary, fiscal and trade) have an explanatory power for the cross-country variation in growth rates and income per capita only because they serve as proxies for institutions. While the authors confirm their results using levels of policy variables (inflation and government spending), they present evidence that policy volatility exerts a strong and direct negative impact on growth. In a cross-section of 91 countries, policy volatility emerges as a key determinant of macroeconomic performance. An increase in the volatility of fiscal policy corresponding to one standard deviation in the sample reduces long-term economic growth by about 0.75 percentage points. Political institutions have a role to play to the extent that they shape policy outcomes.

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