Analysis of expansionary fiscal policy on macroeconomic stabilization in Rwanda: An econometric study

Abstract

Following the oscillating attitude towards fiscal policy as an efficient tool to foster economic stability and the scarcity of studies on the role expansionary fiscal initiatives play on the economic stability of the country, the present dissertation sought to analyse the impact of expansionary fiscal policies on macroeconomic stabilization in Rwanda. It followed the output framework to investigate the dominance of significant fiscal variables namely government spending, tax revenues and investments which are considered to influence macroeconomic stability. The macroeconomic stability indicator considered for this dissertation was economic growth represented by the value of Real Gross Domestic Product. Analysis was executed using annual time series data from 1995 to 2018 and various econometric methods were applied. First, all variables were put under stationarity test using Augmented Dickey Fuller test (ADF) for detection of unit root. The results affirmed the stationarity of variables at first difference with function of constant. Secondly, a Johansen cointegration test was used to check cointegration among variables, the results showed that three or more variables were cointegrated. Subsequently, Vector Error Correction Model (VECM) was applied to present the short run and long run dynamics in the variables. The results showed that government spending and investments positively affect real gross domestic product in the long run, but tax revenues have a negative relationship with real gross domestic product. In the short run, the results found no discernible relationship between any variables. Finally, a Granger-Wald causality test was applied to detect causalities in our variables; the results indicated no causal relationship between real gross domestic product and fiscal policy variables, however, a unidirectional causality was detected by a pairwise causality test from investment and real gross domestic product to tax revenues. This dissertation embraced the Keynesian theory of fiscal policy and recommended strengthening use of fiscal policies in macroeconomic stabilization. It also recommended allocating a bigger portion of government expenditures in investment expenditure as investments were found to contribute greatly to economic growth as a macroeconomic stability indicator.