The Relative Effectiveness of Monetary and Fiscal ‬Policies on Economic Growth in Bangladesh‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬

Md ‬ Abu Hasan

doi:10.11648/j.eco.20160501.11

Abstract

This study explores the relative effectiveness of monetary and fiscal policies on economic growth in Bangladesh for the period from fiscal year 1974 to2015 employing cointegration and Vector Error Correction Model (VECM). We use nominal GDP as a proxy for economic growth, while broad money supply (M2) and reserve money (RM) as proxies for monetary policy. Total government revenue (TR) and total government expenditure (TE) are used as proxies for fiscal policy. The Johansen cointegration tests reveal that monetary policy (M2 and RM) has a greater long run positive impact on economic growth over fiscal policy in Bangladesh. The results of VECM show that there is a weak long run causality running from monetary and fiscal policies to economic growth. VECM also finds that GDP, M2 and TR play a part to adjust any disequilibrium, while TR picks up the disequilibrium rapidly and guides the variables of the system back to equilibrium. VECM Granger causality/block exogeneity Wald test results show that M2 is the leading indicator with respect to economic growth in Bangladesh in the short run. Moreover, economic growth is a leading indicator with respect to fiscal policy in the short run. Thus, we conclude that monetary policy is the more effective channel than fiscal policy to promote economic growth in the short run and long run in Bangladesh.

Highlights

The achievement of macroeconomic goals has been a policy precedence of each and every economy
The error correction term of first differenced GDP is -0.25, which implies that GDP requires about four years to converge into equilibrium after being shocked
We can conclude that GDP, M2 and Total government revenue (TR) contribute to adjust any disequilibrium, while TR picks up the disequilibrium quickly and guides the variables of the system back to equilibrium

Summary

Introduction

The achievement of macroeconomic goals has been a policy precedence of each and every economy. Economic growth has long been regarded as an important macroeconomic goal of economic policy with a considerable frame of research dedicated to explaining how this goal may be accomplished. Fiscal and monetary policies are the main instruments of achieving the macroeconomic goals. Monetary and fiscal policies are both commonly accorded outstanding roles in the pursuit of macroeconomic stabilization in developing countries, but the relative efficiency of these policies has been a major debate between the Keynesians and the Monetarists. Monetarists rely on monetary policy as they argue that money supply plays a major role in achieving macroeconomic goals, while Keynesians contend that fiscal policy is more important in boosting the economic acivity

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