Effects of the Fiscal Policy Shocks under the Debt Feedback Rule in Ethiopia: Evidence from SVAR Model
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Date
2015-01
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Addis Ababa University
Abstract
This study investigates the macroeconomic effects of fiscal policy shocks in Ethiopia under Structural Vectorautoregressive model (SVAR). The model is built on the recent popular shock identification approach and further adjusted to account for the feedback effects of public debt. Under such specification, the intentions are to draw lessons on the dynamic responses of output, inflation, cost of debt and nominal exchange rate to the government expenditure and revenue shocks. In addressing these objectives, the impulse response functions generated through a bootstrap technique are used. Consequently, the result confirms the argument that ignoring the reactions of fiscal and macro variables to the debt level produces incorrect estimates of the effects of fiscal policy for Ethiopia. Besides, shocks in government spending have an expansionary effect on output; lead to quick rise in prices; produce small varied effect on cost of debt; deteriorate nominal exchange rate in the long run and make debt to GDP ratio increase. Alternatively, shocks in revenue have less clear cut, small positive effect on output; temporary price stabilization effect; no meaningful effect on cost of debt; and less stabilization effect on debt ratio. As a result, caution must be taken to ensure increases in spending should not lead to increased debt and inflationary pressure. Likewise, a better revenue collection effort and expanding tax bases in the country could boost growth and reduce debt more.
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Fiscal Policy Shocks under