Institutions, growth and economic stability

This paper investigates the effects of institutions on the countries economic performance, controlling for some macroeconomic policies and disaggregating the impacts by income levels. The empirical analysis considers a balanced panel of 118 countries from 2002 to 2016 and estimates impulse response functions by a Panel VAR model. A positive shock in institutional efficiency increases GDP per capita, reduces government consumption over GDP, and decreases the volatilities of these variables. Institutional improvements raise public spending efficiency, leading to a drop in government size and a simultaneous rise in GDP. Fiscal policy is more sensitive to institutional improvement, constituting an important channel of transmission of the effects of institutions for economic performance. Under all scenarios, the gain in institutional efficiency is more relevant for countries with lower levels of income.