FISCAL DECENTRALIZATION, MACROSTABILITY AND GROWTH

This paper examines how fiscal decentralization may influence economic growth. Previous research on this question has primarily focused on the direct relationship between decentralization and growth. In this paper, we also incorporate the potential indirect influence of decentralization on growth through its impact on macroeconomic stability. We build an augmented neoclassical model of economic growth that allows for both the direct and indirect effects of fiscal decentralization on economic growth. Using panel data, we find that decentralization appears to reduce the rate of inflation in the sample countries, does not appear to directly influence economic growth, and has an indirect, positive effect on growth through its positive influence on macroeconomic stability. An important contribution of the paper is to identify the role of the indirect effects of fiscal decentralization on economic growth.