Determinants of Budget Deficit in Ethiopia
Determinants of Budget Deficit in Ethiopia
Determinants of Budget Deficit in Ethiopia
ETHIOPIA
Submitted to:Frezer
DEPARTMENT OF ECONOMICS,
COLLEGE OF BUSINESS AND ECONOMICS,
HARAMAYA UNIVERSITY
June, 2019
Haramaya, Ethiopia
CHAPTER ONE
INTRODUCTION
1.1 Background of the study
Ethiopia’s growth in the last decade, and in particular in the second half of the decade,
will be appreciated by international observers, including the continental economic
Institutions such as the Economic Commission for Africa (ECA, 2007) and also ‘The
Economist’ magazine in its July 2008 issue. The government has began to openly
argue that Its success is fundamentally related to its rejection of the ‘neo-liberal’
economic policy which is usually referred as the ‘Washington Consensus’ or
Structural Adjustment Policies (SAPs). The government also attributes this growth
success to its embrace of the idea of a ‘developmental state’, the latter usually
referring to a policy of public sector intervention the economy both through policy
and active investment.
This issue surrounding budget deficit are not certainly new, but the economic
development of the past decades has led to renewed interest in the fiscal
themes .Government budget deficit is a perennial topic of debate among policy
makers. Traditional view of government deficit taken by by most economist said that
when government runs a budget deficit and issues deficit. It reduces national saving
which in turn lead to lower investment and a larger foreign debt. This view concludes
that government debt places burden on future generations. While Ricardians view of
government deficit stress that budget deficits merely represent a substitution of future
taxes for current taxes. Budget deficit of government may affect a nation’s role in the
world economy (Mankiw 7th Edition 2007).
In recent years government spending LDC’S has increased significantly. This is
mainly attributed to the fact that the governments of LDC’S are involved in social,
political and economic affairs. Meanwhile revenues do not grow rapidly in the same
proportion as expenditure due to narrow taxes basis and inefficient tax collection of
systems resulting in a budget deficit. In industrial countries, too, the failure of market
mechanism in 1930’s (during great depression) calls for government intervention in
the economy paving the way for increased government expenditure in those countries.
Despite the consensus on the need to reduce budget deficit, LDC’S offer a wide range
of expenditure with budget deficit. From country to country budget led to high and
variable inflation with crowding out of investment and growth .while in some
countries moderately high budget deficit seem not to generate macroeconomic
imbalance at all. The explanation for this different outcome is that different
governments adopt different techniques of financing their deficits. Thus the
consequences of fiscal deficit depend on the way they are financed (William
easterly .files.wordpress.com/2010/08 and Mankiw, 2007)
Ethiopia faces big budget deficit. The combined effect of a very rapid increase in
expenditure and a relatively slower increase in revenue is obviously increase
government’s budget deficit. The budget deficit including grants increased from a
little less than one billion birr in 1996/97 to over 6 billion in 1999/00. The fast
increase in the budget deficit has started in 1997/98 when it more than doubled from
its previous year level to 2.1 billion birr again doubling to 4.5 billion birr in 1999/00.
Budget deficit excluding grants increased from about 2.5 billion birr in 1996/97 to
over 7.7 billion birr in 1999/00. As a proportion to GDP the budget deficit including
grants increased from 2.4% in 1996/97 to 4.5%%, 9.3% and 11.5% respectively in the
following years. the deficit excluding grants rose to as high as 15% of GDP in
1999/00 from its level of 6% in 1996/97 increasing to 7.5% and 13% in the following
two years. this is a significant and certainly unsustainable increase in the country’s
budget deficit and compares unfavorably with the average level of deficit of both the
early years of a new government (4% including grants) and the last years of the
Dergue (8% including grants. in general budget deficit is increase from time to time
(Befekadu Degefe, Berhanu Nega, Getahun Tafesse, 200/01).
As part of the structural reforms agreed with multilateral financial institutions
(MLFIS) the government of Ethiopia was committed to significantly decrease or over
abandon domestic borrowing to finance its deficit. This was considered as prudent
strategy both to curb inflation and even more importantly to avoid crowding out
private investment. However, given the attitude of donors towards the war with
Eritrea and even more their attempt to force the country to accept a peace deal it was
not ready to accept with a treat of cutting off aid the government had option but to
resort to domestic sources to finance the war. This is clearly reflected in the war, the
government financed its deficit. On the side of monetary policy, the government
accepted the advice of the MLFIS and practiced tight monetary policy until 1996/97
where money supplies were increasing at less than the rate of growth of nominal
GDP. Policy changed, however, beginning with the conflict and money supply started
to increase rather considerably. In 1997/98 narrow money increased by 10.7% and
broad money by 12.7% compared with the rate of growth of nominal GDP of 8.1 %
( Befekadu Degefe, Berhanu Nega, Getahun Tafesse, 200/01).
1.4 hypotheses
The following relationships are hypothesized based on the earlier studies (conducted
by Combes and Saadi-Sedik (2006) and tested with reference to the time series data.
There is positive relationship between real GDP annual growth rate
and budget deficit.
There is positive relationship between real per capita GDP and budget
deficit.
There is negative relationship between broad money supply and budget
deficit.
There is negative relationship between the inflation and budget deficit.
There is positive relationship between the real interest rate and budget
deficit.
There is negative relationship between the share of agriculture from
GDP and budget deficit.
There is positive relationship between the real exchange rate and
budget deficit.
Finally, this study may also give a clue for further study about determinants of
budget deficit in the future.
CHAPTER TWO
LITERATURE REVIEW
2.1 Theoretical literature reviews
2.1.1 Government Budget deficit
Analysis of budget deficits remained peripheral in most literature on public finance.
Most of the literature prior to the 1950s focused on separate discussion of the revenue
and expenditure side of government budget where the main occupation of the analysis
is to explain the role of fiscal policies in resource allocation, stabilization, income
distribution and economic growth, and devoted little explanation for budget deficit.
Most of the literature of that period was based on developed countries and mere
discussion of budget deficit was ascribed to developed financial markets which made
deficit financing easy with little impact on macroeconomic variables. Moreover,
Keynesian conception of budget deficit is that of an average balanced budget deficit
over a business cycle, i.e. surplus during boom and deficit during recession as a norm
of fiscal behavior, hence fiscal deficit accordingly was not much of the problem over
a period. Even if analysis of budget deficit got consideration since the 1960s, a
significant number of studies that model the determinants of budget deficit explicitly
were still limited (MANKIW, 2007).
Budget deficit is related to activities of the government. The early mercantilist school
of thought support active government participation. This view was opposed by
classical economist who believed that market mechanism itself can regulate the
economy and therefore government should limit its intervention in the economic
sphere. However in the 1930s (due to great depression) economists started to question
the working of the market mechanism. They recognized that there are some instances’
where the free market operation suggested by the classical does not work correctly.
Models of development in the late 1940s and 1950s focused on market failures in
LDC’S and advocated large government involvement.
Thus all programs taken in those countries during that period like, the big push
balanced growth, redistributions with growth and all the rest suggest more, not less
government involvement. However, large government interventions on the other hand
mean increase in government expenditure.
2.1.2 Concept of budget deficit
Any attempt to assess budgetary impact on macroeconomic variables such as money
supply, balance of payment, public debt and aggregate economic activity requires a
specific measure of the budget deficit. Several concept of budget deficit, however,
seem to be in circulation. Notwithstanding this, a deficit has tended to be viewed as
summary of government receipt and payment in a single budget year. In this context
the conventional deficit is defined as follows;
Fiscal deficit as convectional defined on a cash basis, measure the difference
between total government cash outlay, including interest outlays, but excluding
amortization payment on the outstanding stock of public debt and total cash receipt,
including tax and non-tax revenue and grant but excluding borrowing proceeds. In
this manner budget deficit reflect the gap to be covered by net government borrowing
including borrowing from central bank.
The most widely used purpose-oriented deficit measures are the current account
deficit, the structurally adjusted deficit, the primary deficit and the operational deficit.
2.1.2.1 Current account deficit
The current account deficit of the government is the excess of non-capital
expenditures over non-capital revenue. It depicts government dissaving and could be
used as a measure of the extent to which government exercises prudence in its
financial management.
However, useful the current deficit may be the problems surrounding its calculation
are intractable. A case in point is the treatment of depreciation in enterprise account
on accrual basis, which contradict public sector accounts that tend to be first available
on the basis.
Moreover, the accounting treatment of investment in human capital as current outlay
despite its importance in explaining growth is at odds with the economic treatment.
Furthermore, the recurrent component of any capital project is likely to manipulated
in many ways to give different picture of government saving. Finally in the context of
economic adjustment, the difficulty of separating adjustment induced effects on the
budget from those introduced by external shocks limits the use of the current account
deficit as a measure of fiscal stance.
(Mania, 2007).
For countries with low level of economic development (measured by PCI) the initial
levels of investment in infrastructure and expenditures on social services are very low.
Hence, expenditures as a percentage of the GDP, requires expanding the infrastructure
build new school, clinic….etc becomes significant. On the other hand, revenues on
those countries grow at a very slow rate. The structure and collection of taxes is such
that it adds to a growing deficit. The system of taxes collection in most low income
countries incur considerable time lags. Moreover, the money income elasticity of their
tax system is low. These makes the impact of inflation on the budget deficit,
especially when the deficit is very high, very server. Also, private saving ratios are
positively correlated to the level of economic development. Hence, it is assumed that
government of low income countries will be focused to supplement private saving
more to respond to public expectations. Here the saving is considered as the
mobilization and diversion of the money incomes through deficit financing that would
otherwise be spent for consumption.
2.1.6.2 Growth in government revenue
The need to deficit financing decreases when revenue grows rapidly while
expenditure grows at a lesser pace or decrease. However, in adequate growth of
revenue leads to deficit financing. Moreover, governments with slowly growing
revenues are more likely to resort to deficit financing to support expenditure than
government whose revenues are growing at significant rates.
2.1.6.3 Instability of government revenue
Fiscal discipline in a stiff challenge for government with large revenue fluctuation
government find more difficult to manage fiscal balances when revenue fluctuate
largely than when its growth is slow but stable. This is especially true when the
government is revenue follower.
2.1.6.4 Extent of government participation in the economy
The government’s ability to control expenditure is influenced by institutional,
ideological and structure factors. Among the factors which put upward pressure on
spending are lacks of coordination between financial and physical plans, development
theorizing high share of recurrent expenditure and revenue instabilities.
2.1.6.5 Size of government
The relative size of government sector tends to be highly correlated with increasing
government role in production, consumption and distribution of goods and services.
This includes upward pressure on spending and is a difficult process to reverse it in
the short-term.
In the past the Thailand government usually ran a budget deficit. But in recent years
the deficit has become a surplus because tax capacity relative to GDP has increased
significantly and expenditure over revenues were also reduced. Evidence from the
country show also that the government adopted non-inflationary means of deficit
financing more relaying on domestic borrowing through bonds. Evidence also shows
that there is no clear relationship between inflation and seignorage in the country.
(Virabongase Ramangkura; 1991).
CHAPTER THREE
DESCRIPTIVE ANALYSIS
3.1 GOVERNMENT BUDGET DEFICIT, GOVERNMENT REVENUE,
GOVERNMENT EXPENDITURE IN ETHIOPIA
3.2 Government Budget deficits
This section would reveal the descriptive analysis followed by various variables
incorporated in the model with that of the budget deficit. The aim of the descriptive
analysis is to serve as a base for the econometric analysis.
On average, during the 1974/75-2009/10 period, 61.7 percent of the total government
spending has been on current expenditure the rest being on capital expenditure. This
large size of current expenditure may have impeded growth by reducing the resources
available for capital expenditure. Defense expenditure, poverty targeted expenditure
(which includes education, health and agriculture) and expenditure on interest
payment constitute the most important components of current expenditure with 27.9,
30.7 and 9.1 percent respectively. Over 55 percent of the interest obligation has been
on domestic borrowing. Over the 20 years period, current expenditure has grown
steadily at a rate of 12 percent per annum.
Though its share in government expenditure for the 1974/75-2009/10 period was, on
average, less than that of current expenditure, capital expenditure has grown at a
higher rate (21 percent per annum). The share of capital expenditure has overtaken
that of current expenditure in 2006/07 reaching 52 percent. Growth in capital
expenditure is often considered as a welcome development. Yet capital projects do
not go into operation within the period in which expenditures are made and usually
have long gestation period to bear fruit. Thus, at least for some time to come the
money injected into the economy for financing such projects might lead to
inflationary pressure. The magnitude of such inflationary pressure, however, depends
on the source of finance used and the food supply elasticity in the country.
The government has financed its capital expenditure from three sources. About 66
percent of capital expenditures were financed from central treasury while the rest
from external assistance (15 percent) and external loans (19 percent) (MoFED,
2007/08). The lion’s share of the means of capital expenditure financing coming from
central treasury indicates that domestic money creation might have played significant
role in the current inflationary process. Between 2002/03 and 2006/07, the National
Bank of Ethiopia’s (NBE) direct advance to the government has almost quadrupled
while there has been no major change in central government deposit with NBE or the
foreign assets of the NBE (NBE, 2006/07),despite statutory limits to this.
In general in the last 20 years, government deficit as percentage of GDP has averaged
about 10 percent. To finance this budget deficit, the government resorted to external
and domestic borrowing as well as privatization of public enterprises. For the
1997/98‐2006/07 period external borrowing and domestic borrowing each accounted
for around half of the total deficit with the balance slightly swinging towards
domestic borrowing, while a very small share (4 percent) is taken up by receipts from
privatization proceeds. In the post 2002/03 period, the means of financing the budget
deficit has, shifted from external to domestic bank and non-bank sources, especially
following the 2005 election where donors protested over the election by reducing the
amount of aid and latter changing modality of its delivery from budget support to
provision of basic services (PBS). This has led to the monetization of the deficits. The
use of domestic means of deficit financing as percentage of budget deficit has grown
from 34.4 percent in 2002/03 to 63.8 percent in 2009/10. The budget deficit and the
means of financing it thereof might have played a major role in the current
inflationary process. As can be seen from Figure 2.3, before 2002/03, budget deficits
(including grants) were not associated with inflation mainly due to the conservative
monetary policy stance of the government. After 2002/03 however, any given level of
budget deficit appear to have been associated with ever growing inflation. Domestic
borrowing reached over Birr 6 billion (the net stock of government debt being 42.3
billion birr which doubled since 2002/03) in 2006/07, with over 70 percent coming
from the banking system (see NBE, 2006/07; MoFED, 2007/08).
The budget deficit as a ratio of GDP reflects increasing of budget deficit. As shown in
fig. 3.1 budget deficit as a % of GDP were 3.5% in 1975. From the figure above
largest budget deficit was occurred in 1994/95 which is about 13.5% during post
reform. Average budget deficit as % of GDP was 7.95% during the Dergue regime. In
general we have seen that the overall increasing amount of government expenditure
over revenues has result in a wide budget deficit.
3.3 Government revenue
The government of Ethiopia classified the revenue schedule in to ordinary revenues,
external assistance and capital receipts. Ordinary revenues are further classified in to
direct tax, indirect tax, and foreign trade tax and non-tax revenue.
CHAPTER FOUR
ECONOMETRICS ISSUES
4.1 model specification
Cambes and Saadi-Sedik (2006) used simple theoretical model of budget deficit
determination. To find the determinants budget deficit during the period of 1995 up to
2006. Cambes and Saadi-Sedik specify the following models.
BDi=f (CBIi, lnRGDPi, GRGDPi,URBi, AGRIi, ILLYi, OPENi)
Where i=denotes the time
Where Ei=error term and variables are defined as follows
BDi = denotes the government budget deficit
CBIi= central bank independence
LRGDPi= the log of real per capita GDP
GRGDPi= the real GDP annual growth rate
URBi=the degree of urbanization
AGRIi=the share of agriculture in the GDP
ILLYi= the ratio of liquid liabilities of the financial system to GDP
OPENi=the trade openness
The linear equation is therefore
BDi = BO+ BoCBIi + B1lRGDPi+ B2GRGDPi+ B3URBi+B4 AGRIi+B5 ILLYi+B6
OPENi+ Ei
Following the model specified by Cambes and Saadi-Sedik the budget deficit model
of this study can be specified by using the share of agriculture in the GDP, real GDP
annual growth rate, log of real per capita GDP, real interest rate, real exchange rate,
inflation rate, and broad money supply printed as explanatory variables and budget
deficit as dependent variable.
BDi= f (LRGDPt, GRGDPt, RERt, AGRIt, RIRt, LM2t, IRt)
Where t=denotes time
BDi = denotes the government budget deficit
LRGDPi= the log of real per capita GDP
GRGDPi= the real GDP annual growth rate
AGRIi=the share of agriculture in the GDP
RERI=real exchange rate
RIRt= real interest rate
LM2t= money printed
IRt=inflation rate
The estimated equation is therefore as follows:
BDi = BO+ B1lRGDPt+ B2GRGDPt+B3AGRIi+ B4RERt +B5RIRt+B6M2t+B7IRt+Et
Et= error term
The dependent variable is the budget deficit in the percent of GDP and is taken from
National Bank of Ethiopia (NBE). This measure of budget surplus which excludes net
interest payments of the treasury is probably the most appropriate measure of the
fiscal discipline because it assesses the orientation of the fiscal policy over a year.
Furthermore, from an econometric point of view, this measure allows us to avoid a
potential simultaneity bias between the dependent variable and the principal
explanatory variables.
LRGDP: Real GDP per capita is introduced in the function to indicate the level of
economic development. So higher level of income per capita reflecting a higher level
of development is held to indicate greater capacity to levy and collect taxes (Mankiw,
7th, 2007). This is true concerning the management and efficiency of public
expenditures. Moreover, according to Roubini (1991), the GDP per capita may
capture some sociopolitical effects if social conflicts are more important in poor
countries. The of GDP per capita is positive.
GRGDP- Real GDP annual growth rate- is included in the model as a proxy for
economic activity because government budget balance is sensitive to economic
fluctuation. Indeed , when the level of economic activities low or moderate the
amount of tax revenues collected by the government decreases while social
expenditure increase, that lead to a deterioration of budget balance. Conversely, a
higher economic growth generates an improvement of budget balance (automatic
stabilizers). However, some authors (Talvi and Vegh, 2000) have suggested that fiscal
policy can be procyclical in developing countries with weak governments, because
political pressures to increase public spending go hand in hand with the growing tax
revenue due to higher economic growth. The strong increase in the fiscal demands
during economic boom is called “voracity effect” (lane and tornell, 1999).
AGRI- share of agriculture in the GDP-According to Tanzi (1992) country’s
economic structure is an important factor that could influence the level of taxation.
For this reason, the share of agriculture in GDP is included. Nevertheless, the
expected sign of AGRI is uncertain because the theory distinguishes two opposite
effects of the share of agriculture in GDP on the tax share. Thus, on the supply side
the share of agriculture in GDP: is expected to have a negative effect on tax revenues
because political constraints could encourage the government to cut taxation in this
sector, often heavily taxed in many implicit ways through import quotas, tariffs,
collected prices of output or overt valued exchange rates. Moreover, agricultural
sector in LDC’s is mainly characterized by subsistence farming and the predominance
of small farmers and so, it appears difficult for a government to tax the main foods
that are used for subsistence (Stotsky and Wolde Miriam, 1997). Conversely on the
demand side, the share of agriculture in GDP is expected to have a positive effect on
budget surplus because many public sector activities being city oriented, the demand
for public goods and services and so the public expenditures are theoretically reduced
(Teere, 2003).
M2 :( Woo, 2003) included as a process for the financial market development level,
the so called “financial depth”. According to Woo (2003) “countries with higher
developed financial markets can more easily finance the budget deficit by issuing
bond, without having resort to inflationary finance.
IR: Keynesian believes that the great depression could have been averted if the
government had engaged in more government spending and income tax cuts (fiscal
policy). Inflation reduces real tax revenue and thus causes high fiscal deficit. This is
called the inflationary approach to fiscal deficit. Sometimes the situation may be
described as “olvera –Tanzi effect” of fiscal deficit, i.e. deficit caused by a decline in
real tax revenues during period of high inflation as a result levels reduce real tax
revenues of the government significantly as the government collects and accounts its
tax receipts in latter and expenditures causing high budget deficit in the country
(Carlos Rodriguez: 1994).
RIR: According to Keynesian economics lower real interest rate will lead both the
consumer and business capital spending both of which increases equilibrium national
income. This is because lower interest rates induce investment which in turn increases
output and hence increases revenue. Higher interest rate inhibits investment; lowers
output and hence reduces revenue.
RER: export supply of the country decreases due to the appreciation of exchange rate
then this aggravate the growth of public fiscal deficit.
4.2. Results of ordinary least square (OLS) estimation
BD=-23.99426--542.3924LRGDP+5.658793IR-839.3519LM2+506.6771RIR--
6.019493AGRI-1037.398RER-5.719545GRGDP
The value of the constant term -23.99426, which is also significant, shows that BD
will have a value of -23.99426 units if all the explanatory variables (included in the
model) are zero. It may also imply the impact of excluded variables on BD, other
variables kept constant.
As economic theoretically, holding other variables constant, as real GDP per capita
increases by 1 million birr budget deficit decreases by 542.3924 units. The
relationship between BD and real GDP per capita negative, which is not confirmed
with hypothesis of the study. This relationship is insignificant. Economic theory say
that higher level of income per capita leads to higher level of development which
indicates greater capacity to levy and collect taxes.
Inflation rate is positively related with budget deficit and which doesn’t conform to
the hypothesis of the study and its t-value shows that it not statistically significant.
When there is high inflation there is high budget deficit because taxes collection
exhibits lags and tax revenue would decrease at the time of collection.
Budget deficit and money printing have negative relationship which does confirm
with hypothesis of the study and its t-value shows that it’s statistically significant.
When the broad money supply in the country is high due to inflow of money from the
foreign the expenditure of government increase this leads to high budget deficit.
Real interest rates have positive relationship with budget deficit and its t-prob is
statistically significant and it’s confirmed with the hypothesis of the study. This result
contrary to economics theory which say that when real interest rate is low the
investment expands and the GDP expands which leads to low budget deficit.
Budget deficit have negative relationship with agriculture share of GDP and it’s
statistically insignificant which is confirmed with the hypothesis of the study.
Agriculture in Ethiopia is mainly characterized by subsistence farming and the
predominance of small farmers and it appears difficult for government to tax the main
foods that are used for subsistence. Due to this government revenue decreases and
budget deficit becomes high.
An increase in the real exchange rate by1 birr, keeping other things constant, reduces
budget deficit by 1037.398. This relationship is found to be significant. As theoretical
expectations Real exchange rate is negative relationship with budget deficit and it’s
statistically significant which is not confirmed with hypothesis of the study. When
real exchange rate is overvalued this leads to expansion of exportable and import
competing sectors and the GDP increase this leads to low budget deficit.
Real GDP annual growth rate have negative relationship with budget deficit and it not
statistically significant even though it not confirmed with the hypothesis of the study.
When the level of economic activities is low the amount of tax revenues collected by
government decreases while social expenditure increases (further information refer
appendix ).
4.2.1 Testing stationary
To estimate a more specific relationship between budget deficit and its determinants
we have to sure that the time series data is stationary. Most economic data are non-
stationary (random walk). There exists a trend element in which both the independent
variables and dependent variables grow up ward or decreases down ward
continuously together.
Running ordinary least squares (OLS) on this data give higher R2 which seems as the
explanatory variables well explain the regressed. However, the higher magnitude of
the multiple coefficient of determination (R2) arises from spurious (false) relation
ship between the dependent and independent variables (Thomas, 1993).
If the time series data are found to be non-stationary most of classical assumption for
econometric estimation will be violated clearly, if available data mean and variances
will change over time. In such cases econometric results may not be ideal for policy
making because the OLS estimation gives inconsistent estimates (Gujarati, 1995).
In the past the popular method to overcome the problem was to estimate the rates of
changes between variables instead of using their absolute levels. However, this
doesn’t capture the long-run information of the model. Besides, the disturbance term,
this is obtained after first differencing auto correlates.
The common tests used are Dickey Fuller (DF) and Augment Dickey Fuller (ADF)
tests. These tests are basically required to ascertain a number of times variables have
to be differenced to arrive at stationary. A time series data are said to be differenced
of ordered ‘p’ if it become stationary after differencing it ‘p’ times. Economic
variables stationary from the outset are I (0) series and a variable that requires to be
differenced once to be stationary is I (1) series (Gujarat, 1995).
Table 4.1 Stationarity test results
Variables ADF-test 1% Critical 5% Critical 10% Critical
value value value
BD -3.592 -3.702 -2.980 -2.622
RGDP -3.858 -3.696 - 2.978 -2.620
CPI -6.014 -3.702 -2.980 -2.62
M2 19.729 -3.689 -2.975 -2.619
NIR -6.220 -3.696 -2.978 -2.620
AGRI -6.437 -3.702 -2.980 -2.622
RER -2.675 -3.702 -2.980 -2.622
GRGDP -4.787 -3.696 -2.978 -2.620
Using the augment dickey fuller (ADF) test real GDP annual growth rates, agriculture
share of GDP and broad money are stationary without differencing the values or with
(0) lags. But budget deficit, real per capita GDP, nominal interest rate, real exchange
rate and inflation becomes stationary after differencing the values of the variables and
with (1) lags.
From the above results, it can be shown that 51.01 % of the variation in consumer
price index is explained by the independent variables. In simple the model explains
51.01% of the variation in the dependent variable, i.e. CPI. The adjusted R2 value,
which accounts for the number of variables, shows that the explanatory variables
account for 51% of the variation in consumer price index. The over all significance of
the model is also significant. This shows the variable that the variables incorporated in
model account for the changes in the dependent variable (refer appendix)
4.2.3 F- test
Testing of the significance of the whole explanatory variables simultaneously using F-
test.
F –test H0-all slope coefficients are zero
H1-all slope coefficients are different from zero
F = ESS/Df = ESS/K-1
RSS/Df RSS/n-k+1
CHAPTER FIVE
5.1 Conclusion and Policy Implications
It was attempted to achieve objectives of the study with the data obtained from NBE
using two techniques of analysis. This chapter aims to link the objectives of the study
with the result obtained and draw some policy implications. It has been stated that
fiscal deficit are at the forefront of macroeconomic problems after the 1980s and
1990s in both developing and developed countries. The result of works on deficit has
been mixed that some empirical work have resulted positive relationship while other
have found clear cut negative relationship between budget deficit and its financing.
As to the causes of rising budget deficits, it has been argued that it was mainly caused
by the growth of expenditure over revenue. Apart from this, there were four reasons
discussed in the literature as to why government may open to high fiscal deficit level;
political reasons, that governments may deliberately favor high spending levels and
low tax rates to make there government legitimate; structural reasons; which makes
the economy inflexible in the short term; inflation, that reduces the real balance of tax
revenue as a result of the existence of collection lags and finally development
theorizing.
The descriptive analysis has reveled that expenditure has been persistently growing
due to the growth of the public sector economy. In turn, this has created budget deficit
since it was not followed by equally proportionate growth revenue. Since 1974, large
and rapid expansion of state activity in the economy has led to the growth of both
government revenue and spending with the dominance of the latter. As a result,
budget deficit have been growing over time.
Looking further in to the structure of current expenditure and capital expenditure the
relative share of the current expenditure was high.
For much reliable conclusion econometric analysis was employed to examine the
empirical relationship between budget deficit and it’s financing. To this effect, the
model specified in chapter four is estimated using the available data and the ordinary
least square method.
In the econometric analysis, the attempt has been made to test the hypothesis that
financing budget deficit through money creation leads to high inflation, domestic
borrowing to finance budget deficit leads to crowding out effect and excessive resort
to foreign borrowing for financing budget deficit leads to high external debt a service
burdening.
To reduce budget deficit the government should restructure its budgeting system and
mode of financing. To this end, the policy implication that emanates from the study is
the following.
To increase tax revenue and decreases the deficit problems, fundamental
reform of tax structures should be made and the reform should focus on
broadening the tax bases (as opposed to mounting high tax rates), minimize
tax exemption and improve the tax administration system which would affect
the tax collecting systems.
The government should also exercise control over its expenditures and its
financing techniques especially through limiting its domestic borrowings from
banks.
Finally the fact that GDP growth in the country follows agricultural growth
trend implies that agriculture is the key to economic growth in the country.
Since the sector is subjected to several of the nature which are beyond policy
measures and control, due emphasis should be given to other sector of the
economy. Apart from policies directed towards improving productivity in
agriculture. In addition, the government should, not only formulate, but also
implement appropriate policies to further encouraging private sector
investment and saving which should gear the country to the pace of rapid
economic growth.
APPENDIX
Stationarity test
1. Dfuller budget deficit, lags (0)
Dickey-Fuller test for unit root Number of obs = 33
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Befekadu Degefe, Berhanu Nega, Getahun Tafesse, 200/01 “Second annual report on
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Clayton, 1995 “economics principles and practices” video disc edition.
Easterly W and Fisher’s (1990)”The economics of the government budget deficit
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network
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INTERNET SOURCES
Http //:www.William easterly .files.wordpress.com/2010/0
http://apcentral.collegeboard.com/apc/public/repository/
ap06_macroecon_syllabus1.pdf
http://www.cardiff.ac.uk/carbs/econ/workingpapers/papers/E2008_25.pdf
http://swbplus.bsz-bw.de/bsz118062182kap.pdf