Abstract:
study was to examine effect of fiscal policy shock on economic growth in Ethiopia
using Structural Vector Auto Regression model. It uses yearly data over the period 1980 to
2008 Ethiopian Fiscal Year. The effects of real government spending and real tax revenue
shocks have been analyzed through impulse response functions and variance decomposition.
The result shows that the effect of government spending on GDP is positive (0.12 percent)
and significant. This means government can stimulate the economy through its
spending. Similarly, the sign on tax effect on GDP is negative. However, the effect of
tax is statistically insignificant.
The study also examined the dynamic responses of real GDP growth rate to changes in
real government spending and real government tax revenues. The result shows that after
two and half years the response of RGDP increase in government spending on Real
GDP is around 0.7 percent with similar magnitude of negative 0.25 percent fall in after
two and half years of response.
The study also see the effects of fiscal policy variables on Real GDP growth rate, the
FVEDs estimation has been carried out and analyzed. The result shows that the shocks
to Real GDP itself explain almost all of its forecast error variance at short horizons.
The shocks to Real GDP are explained by the forecast error variance of tax revenue
and government spending approximately 8 and 10 percent. Tax revenue shocks are
found to have relatively small impact in the initial years and grow through time to the
level that government spending impact.
The important policy implication of the study is government to continue the expenditure
trend but be cautious of the tax. Financing government spending needs a careful
consideration so as to continue spending effect in stimulating the economy. The effect of
Tax on GDP growth is negative, which requires expanding the existing narrow tax base
which in turn necessitates increasing the capacity to collect and administer tax.
