Fiscal Policy, Inflation And Output Growth in Kenya: An Asymmetric Approach

Abstract

Fiscal policy is one of the tools employed by the Kenyan government to enhance economic performance towards realization of the Kenya Vision 2030 as the blueprint for economic, social and political development. However, the gross domestic product in Kenya has been below the targeted 10% as inflation rates fluctuate above the 5% target. Therefore, the study investigated the effect of fiscal policy on inflation and output growth in Kenya using an asymmetric approach for the period between 1991 and 2021. The study differs from previous studies by applying the non-linear autoregressive distributed lag modelling to capture asymmetric dynamics. The study identified a long-run equilibrium and cointegrating relationship among the study variables, with the findings revealing the existence of a long-run asymmetric effects of public debt and government spending on inflation as well as asymmetric effect of government spending on output growth. A positive relationship between previous increases in public debt and current inflation in the short-run was also established, while decreases in public debt was found to increase inflation in both the long-run and short-run. Similarly, positive changes in government spending raise inflation. Decreases in tax revenue was found to have a negative effect on inflation in the long-run. On the other hand, the short-run results indicate that reductions in tax revenue have positive effect on output growth, whereas increases in tax revenue reduce output growth in the long-run. Additionally, increases in public debt have negative short-run effect on output growth. The findings also indicated the existence of a persistent negative effect of decreases in government spending on output growth into the long-run. Positive changes in government spending result to an increase in output growth in the long-run. As such, the study recommend that the government should direct its expenditures toward productive sectors such as infrastructure development to reduce the cost of doing business and enhance efficiency in service delivery to accelerate growth and development. The study also suggests on proper management of public debt by ensuring that any additional expenditures contribute positively to the overall growth by ensuring a balance between achieving economic growth while avoiding adverse effects for inflation.