Fiscal policy can be applied with a stabilisation intention if government finance choices can influence household consumption behaviour. According to Keynes, expansionary fiscal policy is the best economic stabilisation tool.
This article examined the crowding in effects of fiscal policy on household consumption whilst investigating the effectiveness of fiscal policy in Kenya.
Household consumption is a key indicator of economic well-being in any economy. Despite its importance, empirical studies examining the relationship between fiscal policy and household consumption are limited in Kenya. In addition, empirical studies on this subject focused on the linear or the symmetric effects of fiscal policy on household consumption.
The objective of this study was to investigate the asymmetric effects of fiscal policy on household consumption in Kenya.
This study employed a quantitative research method using time series data which ranged from 1971 to 2018. The nonlinear auto-regressive distributed lag (NARDL) model was used in the empirical analysis.
In the short run, fiscal policy was found not to affect household consumption. However, fiscal policy was found to have asymmetric effects on household consumption in the long run.
The study revealed that, in the long run, negative changes in tax revenue crowd in consumption whilst other factors do not have a significant effect on household consumption.
This study informs the Kenyan government on the best way to follow when fiscal policy tools must be employed to boost household consumption.
Fiscal policy entails the government’s deliberate interventions established to boost a country’s economic performance and achieve set objectives (Mutuku
Kenya has previously used budgetary expenditure changes and tax adjustments as fiscal tools to boost aggregate demand and economic performance. The overuse of expansionary policy has fuelled rapid growth in government expenditure over the years. For instance, in the last five decades, government expenditure grew by more than 100% (WBG
Tax rate adjustments and public debt were employed to finance the rapidly growing government expenditures. From the mid-1970s to the mid-1980s, financing of government expenditure was through personal and corporate tax rates (Karingi & Wanjala
From time to time, Kenya has recorded a rise in fiscal deficit, resulting from the continued rapid growth of public expenditure unequal to growth in government revenue. According to Mutuku (
Widening the tax bases in every fiscal year has become a norm in Kenya. Also, tax revenue has experienced some growth to match the rising government expenditure. According to Keynes (
Consequently, household consumption expenditure should be crowded out as tax increases. However, in the case of Kenya, household consumption has been increasing. For example, household consumption was observed to grow at an average of 77% of GDP between 1997 and 2006 (Kenya 2003; WBG
Fiscal policy is amongst the tools many governments apply to maintain macroeconomic stability for growth and prevent market failures. Fiscal policy can affect the orientation of wealth accumulation and affect macroeconomic expansion and contraction. It can also influence intergenerational transfers via taxation on extractable resources, debt and subsidies (M’Amanja, Lloyd & Morrissey
An increase in government expenditure directly affects the economy by inducing high demand for goods and services. Consequently, this leads to an increase in income and employment, thus indirectly boosting household consumption (Parkin et al.
The more specific objectives of the study are:
to evaluate the asymmetric effects of fiscal policy and public debt on household consumption in Kenya for the period between 1971 and 2018
to investigate whether fiscal policy crowds in household consumption in Kenya
The effect of fiscal policy on household consumption is controversial in both empirics and theories of economics. On theoretical grounds, there are various schools of thought on this issue. One is the absolute income hypothesis (AIH), in which Keynes (
On the contrary, under the neoclassical theory, the standard real business cycle model was of the idea that an increase in government expenditure decreases private or household consumption, and in general, the government can finance its expenditures from different sources (Friedman
Barro (
There has been an upsurge in the empirical studies trying to unravel the crowding-in effect of fiscal policy on household consumption. However, the results are inconclusive. Further inconsistency emanates from the analytical approaches used to test the relationship between the two. The common analytical approach is to present a linear model of the relationship between the two.
Khanfir (
A study carried out by Merko et al., (
Using yearly data from 1990 to 2017, Kusairi, Maulina and Margaretha (
Anderson, Inoue and Rossi (
Banday and Aneja (
Belingher and Moroianu (
In addition, Saraswati and Wahyudi (
From the reviewed literature, it is evident that there are mixed results on the crowding-in and crowding-out effects of fiscal policy on household consumption. For instance, Khanfir (
Banday and Aneja (
The study sought to examine the crowding-in and crowding-out effects of fiscal policy on household consumption, considering a nonlinear relationship between household consumption, fiscal policy (proxied by government consumption and tax revenue) and the other control variables (public debt and inflation). A quantitative research design was adopted as it allows for correlational research analysis. Correlational research design helps identify relationships amongst variables and also predicts possible outcomes. If a relationship of sufficient magnitude between variables exists, it is feasible to forecast a score on either variable with a known score of the other variable. This research design actualised the general study objective to establish the relationship between fiscal policy and household consumption in Kenya.
The empirical work of this study was built from the AIH (developed by Keynes in 1930), which assumes consumption to be an increasing factor of income (Alimi
The given consumption function was modified to take aggregate consumption and income, as represented in
When the government increases taxation, disposable income
According to Keynes (
Keynes (
For most of the studies conducted to evaluate the impacts of fiscal policy on household consumption, government expenditure and tax revenue have been used as proxies for fiscal policy. Likewise, the current study used government consumption expenditure and tax revenue as proxies for fiscal policy.
Therefore, the aggregate consumption function at time
Keynes (
The study relied on secondary data for empirical analysis. A time-series data set covering the period from 1971 to 2018 was retrieved from various public domains in percentage form with no further transformation.
Data source.
Variable | Source | Description of the variable |
---|---|---|
Household consumption (HC) | World Bank | Total household consumption expenditure (% of GDP) |
Government consumption expenditure (GC) | World Bank | Total government consumption expenditure (annual) |
Real GDP (Y) | World Bank | Real gross domestic product (annual % growth) |
Tax revenue (TR) | IMF and KNBS | Total tax revenue plus grants (% of GDP) |
Public debt (PD) | Kenya public debt reports and KNBS | National public debt (% of GDP) |
Inflation rate (INF) | World Bank | Inflation rate (CPI index) |
Correlation matrix results: Household consumption and independent variables.
Variables | HC | GC | TR | PD | Y | INF |
---|---|---|---|---|---|---|
HC | 1.000 | - | - | - | - | - |
GC | 1.000 | - | - | - | - | |
- | - | - | - | - | ||
TR | −0.138 | 1.000 | - | - | - | |
0.351 | - | - | - | - | ||
PD | −0.171 | 0.692 | 1.000 | - | - | |
0.245 | 0.000 | - | - | - | ||
Y | −0.151 | 0.217 | −0.382 | −0.471 | 1.000 | - |
0.307 | 0.138 | 0.007 | 0.001 | - | - | |
INF | 0.274 | −0.014 | 0.102 | −0.411 | 1.000 | |
0.059 | 0.926 | 0.488 | 0.004 | - |
Note: The values on bold were meant to stress on the most important correlation coefficients.
HC, household consumption; GC, government consumption expenditure; TR, tax revenue; PD, public debt; Y, real GDP; INF, inflation.
The results show that government consumption expenditure, real GDP and inflation are negatively associated with household consumption with pairwise correlations of 0.25, 0.15 and 0.35, respectively. However, the real GDP growth correlation was not statistically significant. Interestingly, tax revenue is positively associated with household consumption with a pairwise correction of 0.57 (
Results in
A strong positive association was observed between public debt and tax revenue with a pairwise correlation of 0.69, which is statistically significant (
Visual inspection of the data trends suggested the existence of structural breaks. A structural break test was also conducted on all the variables using the Zivot–Andrew test.
The Zivot–Andrew breakpoints graph, represented in
Zivot–Andrew breakpoint test.
The nonlinear autoregressive distributed lag (NARDL) bounds testing model established by Shin, Yu and Greenwood-Nimmo (
It can capture the asymmetric effects and hence can capture economic frictions, leading to vertical movements in the economy (Chen et al.
The model can be used on variables with I (0) and I (1) orders of cointegration.
It can capture both the short-run and the long-run effects.
The model also assumes that the response of the dependent variable to the decomposed positive and negative changes of the independent variable (increase [+] and decrease [−] of each independent variable) is asymmetric (Shin et al.
The model estimation was initiated with a unit root analysis to determine the stationarity of the variables and ensure the order of integration of the variables using the standard augmented Dickey–Fuller test and Philips Perron unit root test. From the stationarity test, household consumption, tax revenue and public debt were found to be integrated of order one, I(1). On the other hand, government consumption, national income and inflation were integrated of order zero, I(0). After confirming that none of the variables was integrated of order two I(2), the study went ahead to test for the appropriate lag length.
The Schwarz information criterion (SIC) identified one lag as the optimal length for independent and dependent variables. The NARDL bounds test for long-run asymmetric cointegration was performed by checking Wald F-statistics against Pesaran et al. (
The bounds test results showed the calculated
The results of the NARDL ECM specified in
This section presents the findings of both the long-run and the short-run NARDL models.
The long-run NARDL model helped evaluate the long-run asymmetric relationship between the dependent and the independent variables.
Long-run results.
Variable | Coefficient | Standard error | Probability value | |
---|---|---|---|---|
GC+ | −0.156 | 0.111 | −1.399 | 0.173 |
GC− | 0.041 | 0.155 | 0.264 | 0.794 |
TR+ | 0.073 | 0.548 | 0.134 | 0.894 |
TR− | −0.944 | 0.507 | −1.864 | 0.073 |
PD+ | −0.046 | 0.082 | −0.557 | 0.582 |
PD− | 0.032 | 0.068 | 0.471 | 0.641 |
INF+ | 0.196 | 0.138 | 1.419 | 0.167 |
INF− | −0.181 | 0.128 | −1.413 | 0.169 |
Y+ | 0.640 | 0.264 | −2.422 | 0.022 |
Y− | 0.043 | 0.286 | 0.149 | 0.883 |
C | 63.882 | 4.022 | 15.883 | 0.000 |
- | 95.40% | - | - | |
Adjusted |
- | 92.77 | - | - |
Durbin–Watson statistics | - | 2.15 | - | - |
GC, government expenditure; TR, tax revenue; PD, public debt; INF, inflation; Y, real GDP.
In the long run, both positive and negative changes in government expenditure (GC+, GC−) were found to have no significant effect on household consumption. The results also revealed that positive changes in tax revenue (TR+) had no significant effect on household consumption. However, negative changes in tax revenue (TR−) had a statistically significant coefficient of −0.944, meaning that if tax revenue decreases by 1%, household consumption expenditure increases by about 0.94%.
In the long run, both positive and negative changes in public debt (PD+, PD−) have no significant effect on household consumption. In addition, positive changes in real GDP positively impacted household consumption (0.640,
An
The short-run impacts of fiscal policy and public debt on households’ consumption are summarised in
Error correction model results.
Variable | Coefficient | Standard error | Probability value | |
---|---|---|---|---|
D(TR−) | −0.153 | 0.392 | −0.390 | 0.699 |
D(INF+) | −0.028 | 0.058 | −0.492 | 0.626 |
D(INF−) | 0.023 | 0.055 | 0.415 | 0.681 |
D(Y+) | 1.152 | 0.186 | −6.208 | 0.000 |
MD | 5.593 | 0.702 | 7.971 | 0.000 |
ECT | −1.107 | 0.124 | −8.927 | 0.000 |
ECT, error correction term.
Negative changes in real GDP, positive and negative changes in government consumption, positive and negative changes in public debt and the positive changes in tax revenue were omitted from the ECM output as they have no significant effect on household consumption in the short-term run. Moreover, in the short run, negative changes in tax revenue (D [TR−]) have no significant impact on household consumption. Likewise, positive and negative changes in inflation (D [INF+], D [INF−]) do not have a significant impact on households’ consumption. Looking at the coefficient of the positive changes of real GDP(D[Y+]; 1.1519), it can be said that in the short run, if national income increases by 1%, household consumption increases by about 1.15%, and the relationship is statistically significant at 1% level of significance (
The dummy variable MD is statistically significant, revealing that household consumption was higher between 1995 and 2018 compared with 1971–1994. The change of governance from a single party to a multiparty country significantly affected household consumption in Kenya.
The error correction term (ECT) captured the speed of adjustment towards equilibrium, and it also showed the amount of disequilibrium corrected in the model each year. The ECT (−1.106805) is negative and statistically significant;
The study used cumulative dynamic multipliers for fiscal policy to check the dependent variable’s adjustment pattern (household consumption) to its new long-run equilibrium following the positive and negative unitary shocks in government consumption and tax revenue.
Dynamic multiplier, government consumption expenditure on household consumption.
The dynamic multiplier for the negative changes in tax revenue indicates that household consumption responds positively to the negative shocks of tax revenue. On the other hand, the multiplier for positive changes in tax shows that household consumption does not react to tax increments in Kenya. In the long run, the dynamic multiplier effects are constant as portrayed in
Dynamic multiplier, tax revenue on household consumption.
Several model diagnostic tests were carried out. The Breusch–Godfrey Lagrange multiplier (LM) method was adopted in testing for serial correlation. The null hypothesis H0; no serial correlation, was tested against the alternative H1; the presence of serial correlation. The test results recorded in
Postestimation diagnostic tests.
Diagnostic test | Critical value | Probability | Decision | |
---|---|---|---|---|
Serial correlation | 0.05 | 3.396701 | 0.2361 | Do not reject |
Specification test | 0.05 | 1.2721 | 0.2693 | Do not reject |
Moreover, the Ramsey RESET model specification test was conducted to test model specification errors. The results showed that the calculated
The CUSUM and CUSUM SQ tests of stability revealed that the parameters used in the regression model were stable. Both lines lie within 5% critical bounds, as presented in
(a) CUSUM and (b) CUSUM of square.
In the long run, the results show that contractionary fiscal policy (decrease in government consumption) and an increase in tax revenue did not have any significant effect on household consumption in Kenya. These findings are in line with Saraswati and Wahyudi (
Both the positive and the negative changes in public debt were found not to have significant effects on household consumption in the long run. This indicates that households in Kenya are long-sighted and they do not view public debt as net wealth; hence they do not alter their consumption patterns as a result of an increase or decrease in public debts.
This study improved the existing literature on the relationship between fiscal policy and household consumption by adopting a different methodology that allowed for asymmetry in the independent variables. In the long run, the findings on whether fiscal policy crowds in household consumption revealed that only low tax rates were able to boost household consumption during bad times. Hence, it can be said that expansionary fiscal policy crowds in household consumption in Kenya. This suggests that keeping taxes at low levels could work better at crowding in household consumption in bad times.
In the short run, fiscal policy and public debt did not have a significant impact on household consumption. However, only real GDP significantly affected household consumption, suggesting that maintaining stability in the national income in Kenya is crucial.
This article aimed to examine the asymmetric effects of fiscal policy on household consumption and to investigate whether fiscal policy crowds in or crowds out household consumption in Kenya. The study examined both the short-run and the long-run effects using the nonlinear ARDL model. The main findings were that expansionary fiscal policy (through a decrease in tax revenue) has a significant crowding-in impact on household consumption. From the dynamic multiplier observation, the crowding-in effect of tax revenue dominates that of government expenditure.
Public debt and inflation, which were used as control variables, were found not to have significant effects on household consumption, both in the short run and in the long run. National income is the only variable found to have a significant impact on household consumption, thereby emphasising the importance for the country to concentrate more on factors that boost national income in order to boost household consumption.
As usual, researchers encounter many challenges in their research. Some of the limitations that the researcher came across in this study are as follows:
Household disposable income data for Kenya could have helped to directly observe tax adjustments’ implications on consumption. However, household disposable income data were not available.
The available tax revenue included grants, so it is not pure tax revenue.
The government of Kenya needs to watch the enormous growth of government expenditure and develop long-term policies that control redundant government expenditures, because it makes the country continuously operate under a budget deficit, hence an excess public debt.
Having used secondary data in this study, the results of this study could be improved by using primary data. A different method of data analysis could also be used to validate this study’s findings.
The authors have declared that no competing interest exist.
N.M. did literature review, research methodology, data collection, data analysis and interpretation of results whilst S.M. assisted with the supervision and final layout of the manuscript.
This article followed all ethical standards of research without direct contact with human or animal subjects.
This research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors.
The data were retrieved from the World Bank database, the Kenya National Bureau of Statistics and Kenyan public debts reports.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors.
A negative coefficient on a negative change in the independent variable is interpreted as a positive relationship with the dependent variable as the two forces are moving in the same direction.