The impact of budget deficit on economic growth and its channels in South Africa

Abstract

PurposeThis paper analyses the direct relationship between budget deficits and economic growth, the channels through which budget deficits inhibit growth and finally, the Granger causality between budget deficit and economic growth in South Africa over the period 1975 to 2020.Design/methodology/approachIn a bid to control for endogeneity that is common in economic growth regressions, the author employed the dynamic ordinary least squares (DOLS) approach.FindingsTowards analysing the direct relationship between budget deficit and economic growth, results show that a 10-percentage rise in the budget deficit slows economic growth by 0.2 percentage points. Results show that the growth inhibiting consequences of the budget deficit in South Africa are principally driven by negatively affecting private and public physical capital accumulation growth, as well as a drop in gross national savings. However, results show no evidence of a deficit reduction effect through long term-real interest rate. The findings reveal a one-way Granger causality running from budget deficits to economic growth.Practical implicationsBased on the findings in this article, expanding the fiscal deficit to support growth is not a viable policy option for the South African economy.Originality/valueThe originality of this paper lies in establishing the Granger causality between budget deficit and economic growth, thus adding to the scant literature, as well as establishing the channels through which budget deficit retards economic growth for the South African economy.