Fiscal policy and public debt implications on household consumption: a case of Kenya.

Abstract

Fiscal policy can be applied with a stabilisation intention if government finance choices are capable of influencing household consumption behaviour. After the great depression of the 1930s, Keynes ascertained expansionary fiscal policy as the best economic stabilisation tool during a recession as it can crowd in household consumption.

Empirical studies dealing with fiscal policy and public debt implications on household consumption have concentrated more on developed nations and more so, the studies conducted have been based on the assumption of an obvious symmetric relationship between household consumption and fiscal policy. The study objective was to examine if fiscal policy crowds in/crowds out household consumption, and if the Ricardian Equivalence hypothesis holds in Kenya. An empirical analysis was conducted using secondary data for the period between 1971 and 2018. The Nonlinear Auto-regressive Distributed Lag (NARDL) bounds test was used to evaluate the existence of an asymmetric relationship between household consumption (dependent variable) and government expenditure, tax revenue, public debt, real GDP, and inflation (independent variables).

In the short run, both expansionary and contractionary fiscal policies were found not to affect household consumption; only negative changes in inflation significantly impacted household consumption. However, expansionary fiscal policy (through the negative changes in tax revenue) was found to crowd in household consumption, while positive changes in government expenditure were found to crowd out household consumption in the long run. Positive changes in public debt were found to crowd out household consumption as well. For contractionary policies, lowering government expenditure or increasing revenue was found not to affect household consumption in the long run.

Using the Wald test criteria, the independent variables were found to show an asymmetric impact on the dependent. The research findings of this study disclosed that, in the short run, fiscal policy and public debt do not affect household consumption. However, in the long run, fiscal policy and public debt were found to have a significant effect on household consumption, and therefore it was concluded that REH does not hold in the long run.