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

Abstract

This article proposes a novel approach to empirically identifying government spending multipliers that relies on two features unique to many low-income countries: (1) borrowing from the World Bank finances a substantial fraction of government spending, and (2) spending on World Bank--financed projects is typically spread out over several years following the original approval of the project. The first fact means that fluctuations in spending on World Bank--financed projects are a significant source of fluctuations in overall government spending in these countries. The second fact means that fluctuations in World Bank--financed spending in a given year are largely determined by fluctuations in project approval decisions made in previous years, and so are unlikely to be correlated with shocks to output in the current year. I use World Bank project-level disbursement data to isolate the component of World Bank--financed government spending in a given year that is associated with past project approval decisions. I use this as an instrument for total government spending to estimate multipliers in a sample of 29 primarily low-income countries where variation in government spending from this source is large relative to the size of the economy. The resulting spending multipliers are small and reasonably precisely estimated to be in the vicinity of 0.5. Copyright 2012, Oxford University Press.