The determinants and cyclicality of fiscal policy: Empirical evidence from East Africa

ABSTRACT

As part of the regional integration process, East African Community (EAC) member countries agreed upon macroeconomic convergence criteria that include, among others, harmonizing and restricting the level of fiscal deficits. However, achieving these targets has been faced with heightened vulnerabilities, including those related to the global financial crisis, the COVID-19 pandemic, and domestic policy slippages. Consequently, high fiscal deficits are fast leading to accumulation of debt. This paper investigates the macroeconomic determinants and cyclicality of fiscal policy in a panel of five EAC countries for the period 1980–2020. Using a combination of linear and nonlinear panel ARDL methods, long-run results show that the fiscal deficit is positively associated with current account balance, real per capita GDP, and interest rate;and negatively associated with the GDP deflator, grants, and debt service. Disaggregating fiscal balances into their revenue and expenditure components shows that government spending is procyclical, while tax effort is countercyclical. Specifically, both government expenditures and tax-to-GDP ratios are positively associated with real per capita GDP regardless of whether this relationship is observed during growth accelerations or decelerations. The size and statistical significance of short-run asymmetric effects of real per capita GDP on fiscal policy vary between countries.