Effect of fiscal policy on inflation in Burundi (2004-2022)

Abstract

This study investigated the effect of fiscal policy on inflation in Burundi from 2004-2022, using time series and quarterly data collected from the Institute of Statistics and Economics Studies in Burundi (ISTEEBU) and the Bank of the Republic of Burundi (BRB). The Auto-Regressive Distributed Lag and Error Correction Models were used to investigate the short-run and long-run effects of fiscal policy on inflation in Burundi. The estimated short-run results revealed that inflation had a positive short-run effect on itself in the previous, second and third periods. Tax revenue had a positive effect on inflation in the previous and current periods but had a negative effect at second lag. Government expenditure had a negative effect on inflation at the current period and a positive effect at lag three. The results also, showed that interest rate and external debt had a negative effect on inflation at the current and second previous periods. The long-run estimates show that tax revenue had a positive significant effect on inflation (Coefficient = 109.913, p-value = 0.07) which means that a one percent increase in revenue resulted in an average of 1.09 percentage points increase in inflation. The government expenditure had a negative significant effect on inflation (Coefficient = -34.063, p-value = 0.042) implying that a one percent decrease in government expenditure resulted in an average 0.34 percentage points increase in inflation. External debt had a positive significant effect on inflation (Coefficient = 41.769, p-value = 0.000) demonstrating that a 1% increase in external debt was associated with an average of 0.41 percentage points increase in inflation. Furthermore, the Error Correction Model had a negative coefficient, implying that the interdependence between fiscal policy and inflation corrected its previous period’s disequilibrium at a rate of 0.704% quarterly to reach a steady state. The study recommends the government should decrease the tax rate that decreases prevent the increasing rate of inflation. Moreover, the revenue generated from the tax should reduce the deficit rather than depending on external debt, as a potential factor for short- and long-term inflationary pressure. The government should increase expenses that influence investment to prevent demand-pull inflation because the investment in Burundi is too low and depends on imported goods. These factors attributed the increase in external debt to supplementing the external reserve. Also, the government should reduce external borrowing to supplement the deficit budgets by implementing tax and expenditure reforms that do not depend on tax rates.