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



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.

Full Text:


Abiad, A., & Ostry, J.D. (2005). Primary surpluses and sustainable debt levels in emerging market countries. IMF Policy Discussion Paper, PDP/05/6.

Anca, R. (2011). How to assess public debt sustainability: Empirical evidence for the advanced European countries. Romania Journal of fiscal policy, 2(2), 20-43.

Alesina, A.T., & Campante, F.R. (2008). Why is fiscal policy often procyclical? Journal of the European Economic Association. 6(5), 1006-1036. doi: 10.3386/w11600

Asiama, J., Akosah, N., Owusu-Afriyie, E. (2014) Assessment of fiscal sustainability in Ghana. Bank of Gana, Working Paper WP/BOG-2014/09.

Blanchard, O., Chouraqui, J.-C., Hagemann, R., Sartor, N. (1990), The sustainability of fiscal policy: New answers to an old question. OECD Economic Studies, 15, 7-36.

Bohn, H. (1998). The behavior of US public debt and deficits. The Quarterly Journal of Economics, 113(3), 949–963. doi 10.1162/003355398555793

Bohn H. (2007). Are stationarity and cointegration restrictions really necessary for intertemporal budget constraint? Journal of Monetary Economics, 54(7), 1837–1847. doi 0.1016/j.jmoneco.2006.12.012

Burger, P., Stuart, I., Jooste, C., & Cuevas, A. (2011). Fiscal sustainability and the fiscal reaction function for South Africa. IMF Working Paper. WP/11/69 doi: 10.1111/j.1813-6982.2012.01321.x

Caballero, R., & Krishnamurthy, A. (2004). Fiscal Policy and Financial Depth. NBER Working Paper, No. 10532, doi: 10.3386/w10532

Calderón, C., & Scmidt-Hebbel, K. (2008). Business cycles and fiscal policies: The role of institutions and financial markets. Central Bank of Chile, Working Paper No. 481.

Caporale, G.M. (1995). Bubble finance and debt sustainability: A test of the government’s intertemporal budget constraint. Applied Economics, 27(12), 1135-1143. doi: 10.1080/00036849500000096

Government of Kenya. (2013). Annual Public Debt Report. Government press.

Halland, H., & Bleaney, M. (2009). Explaining the pro-cyclicality of fiscal policy in developing countries. Credit Research Paper, No.11/09.

Horne, J. (1991). Indicators of fiscal sustainability. IMF Working Paper, WP/91/5. doi

Fatás, A., & Mihov, I. (2009). The Euro and fiscal policy. NBER Working Paper, No.14722 doi 10.3386/w14722

Kenya, Government of, Medium-Term Budget Strategy Paper, 2009/10-2011/12(June 2009).

Ilzetski, E., & Végh, C.A. (2008). Procyclical fiscal policy in developing countries: Truth or fiction? NBER Working Paper Series, No.14191. doi 10.3386/w14191

Khalid, M., Malik, W.W.S., & Sattar, A. (2007). The fiscal reaction function and transmission mechanisim for Palstan. The Pakistan Development Review, 46(4), 435-447.

Mutuku, C., & Elias, K. (2014). Monetary and fiscal policy shocks and economic growth in Kenya: VAR econometric approach. Journal of World Economic Research. 3(6), 95-108. doi: 10.11648/j.jwer.20140306.14

Nguyen, T. (2013). Estimating India’s reaction function. ASARC working paper, no.2013/05

Thugge, K., Heller, P.S., & Kiringai, J. (2012). Fiscal policy in Kenya: Looking toward the medium to Long-Term. Unpublished.

Sirengo, J. (2008). Determinants of Kenya fiscal performance. Kenya Institute for Public Policy Research and Analysis, Discussion Paper, No.91.

Morekwa, M.E., Sichei, M.M., & Mutai, N.K. (2007). The monetary and fiscal policy interaction in Kenya. Research Department, Central Bank of Kenya.

Sims, A. (1980). Macroeconomics and reality. Econometrica, 48(1), 1-48.

Campeanu, E., & Stroian, A. (2013). Fiscal policy reaction in the short term for assessing fiscal sustainability in the long run in Central and Eastern European countries. Czech Journal of Economics and Finance, 60(6), 501-518.

Ostry, J.D., Ghosh, A.R., Kim, J.I., Qureshi, M.S. (2010). Fiscal space. IMF position note. IMF, SPN/10/11.

Corsetti, G., & Roubini, N. (1991). Fiscal deficits, public debt, and government solvency: Evidence from OECD Countries. NBER Working Paper, No.3658. doi: 10.3386/w3658

Haug, A. (1995). Has federal budget deficit policy changed in recent years?. Economic Inquiry, 33(1), 104-118. doi: 10.1111/j.1465-7295.1995.tb01849.x

Johansen, S., & Juselius, K. (1990). Maximum Likelihood Estimation and Inference on Cointegration---with Applications to the Demand for Money. Oxford Bulletin of Economics and Statistics, 52(2), 169-21. doi: 10.1111/j.1468-0084.1990.mp52002003.x

Ghosh, A.R., Kim, J.I., Mendoza, E.G., Ostry, J.D., & Qurehi, M.S. (2011). Fiscal fatigue, fiscal space and debt sustainability in advanced economies. NBER Working Paper, No. 16782. doi 10.3386/w16782

Muriithi, M.K., & Moyi, E.D. (2003). Tax reforms and revenue mobilization in Kenya. Economic. Research Consortium, Nairobi. Paper No. 31

Eissa, N.O., & Jack, W. (2009). Tax reform in Kenya: Policy and administrative issues. Initiative for Policy Dialogue Working

Penalver, A., & Thwaites, G. (2006). Fiscal rules for debt sustainability in emerging markets: The impact of volatility and default risk. Bank of England Working Paper No. 307. doi:10.2139/ssrn.933299

Payne, J. (1997). International evidence on the sustainability of budget deficits. Applied Economic Letters, 4(12), 775-779. doi: 10.1080/758528726.

Riascos, Á., & Végh, C.A. (2004). Procyclical fiscal policy in developing countries: The role of capital market imperfections. University of California at Los Angeles, manuscript retrieved 28.01.10.

Haltom, R., & Weinberg, J.A. (2007). Unsustainable fiscal policy. Implications on monetary policy. Federal Reserve Bank of Richmond, Annual Report, 5-19.

Stoian, A. (2008). Analysing causality between Romania’s public budget expenditures and revenues. Theoretical and Applied Economics, 11, 60-64. doi:10.1111/j.1468-0300.2012.00243.x

Trehan, B., & Walsh, C.E. (1991). Testing intertemporal budget constraints: Theory and applications to U.S. federal budget and current account deficits. Journal of Money, Credit, and Banking, 23(2), doi: 10.2307/1992777

Uctum, M., & Wickens, M. (2000). Debt and deficit ceilings, and sustainability of fiscal policy: An intertemporal analysis. Oxford Bulletin of Economics and Statistics, 62(2), 167-222.. doi 10.1111/1468-0084.00168

Karingi, S.N., & Wanjala, B. (2005). The tax reform experience in Kenya. World institute for Development Economic Research. Paper No. 2005/67

World Bank. (1990). Argentina: Tax policy for stabilization and economic recovery.

Country Study. Washington, D.C. The World Bank.

Wyplosz, C. (2011). Debt sustainability assessment: Mission impossible. Review of Economics and Institutions, 2(3), 1-37. doi: 10.5202/rei.v2i3.42

Wyplosz, C. (2012). Fiscal rules: Theoretical issues and historical experiences, NBER

Working Paper, No.17884. doi: 10.3386/w17884



  • There are currently no refbacks.


Journal of Economics Library - J. Econ. Lib. - JEL -

ISSN: 2149-2379

Editor: Secretarial:   Istanbul - Turkey.

Copyright © KSP Library