Relationship Between Fiscal Dominance and Selected Macroeconomic Variables in Kenya
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Over the past four decades, Kenya has been experiencing fiscal instability with average fiscal deficit as percent of GDP being greater than 5 percent threshold for developing countries. This, together with poor donors’ relations in the 1980’s, and the substitution of foreign borrowing with internal borrowing has led to continued increase in fiscal dominance. Kenya has been unable to reach the 10 percent economic growth target required for realization of Kenya’s Vision 2030, with annual economic growth in 2017 being 4.9 percent even with increasing fiscal dominance. Fiscal dominance as a percent of GDP has been moving in the same direction as inflation rate. In 2017, inflation rate reached 8 percent, a rate that is higher than 5 percent CBK target with 2.5 percent margin on either side. Fiscal dominance remains a vital worldwide debate especially for countries experiencing large and persistent fiscal deficit. The question being whether or not fiscal dominance affects price stability of a country and whether or not it stimulates economic growth in developing countries and emerging economies with large fiscal deficits. The general objective of the study was to determine the effects of fiscal dominance on selected macroeconomic variables in Kenya. The specific objectives were to determine the effects of fiscal dominance on inflation rate and to analyze the relationship between fiscal dominance and economic growth in Kenya. The study utilized annual quantitative time series data for the period 1976-2017. The study employed Autoregressive Distributed Lag model to estimate the short run and long run effects of fiscal dominance on inflation rate in Kenya. Granger causality test was used to determine the direction of causality between economic growth and fiscal dominance. The study found that fiscal dominance had a negative effect on inflation rate in the current period. However, the coefficients became positive and statistically significant at 5 percent level of significance after the first year and in the long run. The study also found that fiscal dominance granger causes economic growth in Kenya. Using impulse response functions derived from restricted Vector Autoregressive coefficient, the study found that fiscal dominance had negative impacts on economic growth in the short run but the impact became positive in the long run. The study therefore concluded that, fiscal dominance has adverse effects on inflation rate and on economic growth in the short run. However, it stimulates economic growth in the long run. The study recommends that, Central bank of Kenya should remain fully independent to reduce fiscal dominance.