Fiscal Policy and Economic Growth: Empirical Evidence from Ethiopia

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Addis Ababa University


This study examines the effects of taxes and government spending on economic growth in Ethiopia. This was accomplished using a SVAR framework following Blanchard and Perotti’s (1999) identification methodology on data spanning from the second quarter of 1995 to the second quarter of 2008 Ethiopian fiscal year. The result for the contemporaneous effect of government spending and revenues on real GDP growth has the expected signs. The result shows that the effect of government spending on GDP is positive (0.57 percent) and significant. This means government can stimulate the economy through its spending. Similarly, the sign on tax effect on GDP is negative. However, the effect of tax is statistically insignificant. We have also examined the dynamic responses of real GDP growth rate to changes in real government spending and real government tax revenues. We find that the effects of government expenditure shocks in Ethiopia appear to be positive but small as compared to the Keynesian fiscal multiplier. The sign of the effects of tax policy changes are less clear cut, but again the effects on GDP appear similarly modest. Past fiscal policy is analyzed through a historical decomposition of the shocks in the model and much of the changes in GDP come from itself followed by government spending. The important policy implication of the study is government to continue the expenditure trend but be cautious of the tax. Financing government spending needs a careful consideration so as to continue spending’s effect in stimulating the economy. The effect of Tax on GDP growth is negative, which requires expanding the existing narrow tax base which in turn necessitates increasing the capacity to collect and administer tax. Therefore, the key policy implication is that the Government should continue investing in what has been the trend in the study period; however, it should be cautious of the impact of taxes. Key Words: Fiscal Policy, Economic Growth, Structural VAR, Identification.



Fiscal Policy, Economic Growth, Structural VAR, Identification