Empirical Characterization of the Dynamic Effects of Fiscal Policy Shocks on Key Macroeconomic variables in Ethiopia
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Date
2012-12
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Addis Ababa University
Abstract
The Ethiopian economy has recorded an impressive growth performance for nearly a
decade. The government has had a substantial and persistent size in the economy over
these years. The dynamic effect of fiscal policy on macroeconomic variables is, however,
far from being obvious. The objectives of this study are, therefore, to empirically
characterize the dynamic effects of net government spending, net tax revenue as well as
disaggregated government spending components on key macroeconomic variables in
Ethiopia using quarterly data over the period 1998/99:1-2010/11:4. A five variable and
six variables SVAR models are constructed and the Blanchard and Perotti (2002)
approach is employed to identify structural innovations. Impulse responses and variance
decompositions are then estimated, respectively, to trace out the dynamic effects and
unveil the relative importance of shocks in explaining the endogenous variables in the
models. To substantiate the result, the recursive identification approach based on
Cholesky decomposition is also used. Government expenditure shocks are expansionary
and have inflationary impact at least in the short term. Tax shocks, on the other hand,
have positive effect on output through increasing expenditures and have little impact on
inflation. In view of the narrow tax base, there is a need to enhance the capacity to
collect and administer tax. In normal times capital spending are more expansionary.
Current spending can be used to stimulate the economy at the expense of lower output in
the long run.
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Economic Policy Analysis