Macroeconomic determinants of fiscal policy in east Africa: a panel causality analysis

Abstract

This study investigates the dynamic causality linkages between fiscal deficits and selected macroeconomic indicators in a panel of five East African countries. The research design is based on panel cointegration tests, panel cross-section dependence tests, panel error correction-based Granger causality tests, and panel impulse response functions. Results show that there is long run feedback causality among fiscal deficits and each of the variables that include: real GDP growth, current account balance, interest rates, inflation, grants, and debt service. Short run Granger causality dynamics indicate that there is feedback causality between fiscal deficits and GDP growth; no causality between fiscal deficits and inflation; no causality between fiscal deficits and current account; no causality between fiscal deficits and interest rates; feedback causality between fiscal deficits and grants; and no causality between fiscal deficits and debt service. Impulse response functions show positive and significant impacts of current account balance, inflation, and grants; negative and significant impacts of real GDP growth and lending rates; and insignificant effects of debt service. In the context of the East African Community’s aspirations to achieve convergence on key macroeconomic targets, including the fiscal deficit, this research provides novel insights on fiscal policy determinants and causality dynamics.