An evaluation of fiscal policy effectiveness during banking crises

The late 2000s banking crisis and the attendant surge in fiscal stimulus packages among the world's major advanced economies have exposed economists' divergent views and taxpayers' skepticism on the effectiveness of fiscal policy on the economy. The intersection of fiscal stimulus and banking crisis recovery poses important questions as public debt levels build up to staggering heights owing to the occurrence of banking crises, and there is well-documented evidence that financial crises and associated fiscal stimulus contribute significantly to this phenomenon. Based on an unbalanced panel of 20 OECD countries for the period 1970--2009, this study examines whether during banking crises, changes in governments' cyclically-adjusted primary fiscal balances have a significant asymmetric effect on shortrun economic growth, that is, whether this effect is different from that observed during more "normal" circumstances. Results suggest that fiscal stimulus is likely to have such an asymmetric effect on growth both in the year following a banking crisis and two years after. However, over longer time horizons, other factors operating through monetary policy appear to be more important.