We examine the long-term consequences of teacher discretion in grading of high-stakes tests. Bunching in Swedish math test score distributions reveal that teachers inflate students who have “a bad test day,” but do not to discriminate based on immigrant status or gender. By developing a new estimator, we show that receiving a higher grade leads to far-reaching educational and earnings benefits. Because grades do not directly raise human capital, these results emphasize that grades can signal to students and teachers within the educational system, and suggest important dynamic complementarities between students’ effort and their perception of their own ability.
