Public expenditures, educational outcomes and grade inflation: Theory and evidence from a policy intervention in the Netherlands

• We analyze the relation between resource changes and schools’ grading policies.
• Schools are shown to have an incentive to adjust grading standards when resources change.
• We test the model's predictions exploiting a quasi-experimental setting in the Netherlands.
• Our results provide evidence for grade inflation following additional resource investments.
• True, rather than feigned, success requires sufficiently elevated additional funds.

This article argues that resource expansion can fail to improve actual student performance because it might cause educators to soften grading standards (i.e., induce grade inflation). Our theoretical model shows that, depending on schools’ and students’ reactions to resource changes, the overall effect of resources on education outcomes is ambiguous. Schools, however, have an incentive to adjust their grading structure following resource shifts, such that grade inflation is likely to accompany resource-driven policies. Exploiting a quasi-experimental policy intervention in the Netherlands, we find that additional resources may indeed induce grade inflation, particularly when the resource increase is limited.