Assessing Fiscal Policy Cyclicality and Sustainability: A Fiscal Reaction Function for Kenya

Abstract

Abstract. This study sought to determine whether fiscal policy for Kenya is on a sustainable path by estimating a fiscal reaction function. A fiscal reaction function is a rule derived from an inter-temporal government budget constraint which reveals the response of government to accumulating public debt. It also sought to establish whether fiscal policy responds to business cycles by determining its cyclical nature. The study used annual time series data spanning 1970 to 2013 and multivariate analysis was based on VAR and VECM model. The empirical analysis reveals that, firstly fiscal behavior is incoherent with inter-temporal budget constraint and the moderation is low. This implies that if fiscal adjustment is not done, debt is likely to accumulate. Secondly, election cycles expenditures threaten Kenya’s long run fiscal sustainability. Finally, fiscal policy is a-cyclical meaning that stabilization objective is not considered while conducting the fiscal policy. The study recommends that fiscal rules, independent fiscal committee and comprehensive fiscal regulations laws should be enacted to correct these biases. Keywords. Fiscal policy, Sustainability, Fiscal reaction. JEL. E62, H30, Q56.