The Macroeconomic Effects of A Disaggregated Government Expenditure Shock in Ethiopia: Evidence from a Bayesian VAR Approach

Abstract

This paper investigated the macroeconomic effects of government spending shocks in Ethiopia using a Bayesian Vector Auto Regression model. We examined the dynamic responses of output, inflation, interest rate and exchange rate to Government Spending shocks employing quarterly data from 2000/01Q1 to 2015/16Q4. The empirical evidence suggests that government spending shock had a positive impact on output and inflation but the effect was too small. Initially the interest rate responded negatively to government spending shocks and was positive with small effect and the nominal exchange rate showed deterioration. Furthermore, positive shocks to recurrent expenditure had a persistent positive impact on real output. Recurrent expenditure appeared not to be responsible for inflationary pressure. Interest rate picked up slightly as a result of recurrent spending shocks in the short run. The response of exchange rate to recurrent expenditure was small and remained negative. In contrast, capital expenditure was found to have an insignificant effect on output. The reasons could be the administrative lag and contractual bottleneck that are sometimes involved in executing capital projects and that appeared to be responsible for inflationary pressure.  In the short term, the interest rate responded negatively and the estimated impact on exchange rate was insignificant.

Keywords: Ethiopia, government spending shock, public debt, Bayesian VAR

DOI: 10.7176/JESD/10-19-03

Publication date:October 31^st 2019