Relative Effectiveness of Monetary and Fiscal Policies on Output Stabilization in Developing Countries: Evidence from Rwanda

Abstract

The aim of this study was to explain the relative effectiveness of monetary and fiscal policies in explaining output in Rwanda. The study used a sample of quarterly data for the period 1996-2014. Applying a recursive VAR, the study used 12 variables, including 5 endogenous and 7exogenous variables to the benchmark model and other two specifications were attempted to capture the true contribution of monetary and fiscal policies to variations in nominal output. Obtained results using impulse responses and variance decomposition provide evidence that monetary policy is more effective than fiscal policy in explaining changes in nominal output in Rwanda. In addition, monetary policy explains better output when the VAR model contains domestic exogenous variables than when they are not included, suggesting the relevance of including domestic exogenous variables in VAR specification of monetary and fiscal policies effectiveness on economic variables. Another suggestion is that in order to achieve higher growth, the government of Rwanda should rely more on monetary policy as compared to fiscal policy.

The relative effectiveness of fiscal and monetary policies in promoting Egypt’s output growth: an empirical investigation using an ARDL approach

“…Second, in terms of the variable used as a measure of economic growth, the majority of reviewed studies uses nominal GDP as the dependent variable ( see for instance , Orsmond 1992 ; Bynoe 1994 ; Fatima and Iqbal 2003 ; Ali et al 2008 ; Mahmood and Sial 2011 ; Abu Hasan et al 2016 ; Ajayi and Aluko 2017 ; Richard et al 2018 ). Some researchers, however, such as Rahman ( 2005 ); Hussain ( 2014 ); Şen and Kaya ( 2015 ); Özer and Karagöl ( 2018 ); and Tarawalie and Kargbo ( 2020 ), have used real GDP instead.…”

“…Achieving high, stable and sustainable output growth is one of the fundamental goals of any macroeconomic-stabilization policy. Monetary and fiscal policy actions are the two main policy options that governments use to accomplish this policy objective through reacting to the economic conditions (Rahman 2005 ; Şen and Kaya 2015 ; Abu Hasan et al 2016 ; Usman and ul-Haq 2016 ; Richard et al 2018 ). While monetary policy, managed by the central bank, is mainly concerned with the control of money supply and the management of interest rate and exchange rate, fiscal policy is concerned with how government influences economic output through its expenditure and taxation policy (Mishkin 2012 ; Usman and ul-Haq 2016 ; Ajayi and Aluko 2017 ).…”

“…Empirical findings of these models suggest that monetary actions have a larger, more predictable, and faster impact on economic activity than fiscal actions ( see for instance Andersen and Jordan 1968 ; Andersen and Carlson 1970 ; Carlson 1978 ; Hafer 1982 ). Proponents of these models suggest that monetary policy is more effective as a driving force behind nominal income, arguing against the effectiveness of fiscal policy due to its inflationary and crowding-out effects (Hasan 2001 ; Fatima and Iqbal 2003 ; Rahman 2005 ; Ali et al 2008 ; Richard et al 2018 ).…”

“…The differences in the empirical results of the relevant studies suggest that the relative effectiveness of monetary and fiscal policies largely depends on the prevailing economic and political conditions and structures, which differ between developed and developing countries as well as within each of these two groups of countries (Richard et al 2018 ).…”

Comparing Effectiveness of Monetary and Fiscal Policies on Real and Nominal Sides of the Economy: A Macro Panel Analysis of Selected Developing Countries

“…Coefficients showed that on average monetary and fiscal policy increase the income by 0.40% and 0.65% respectively in Nigeria. (Richard et al, 2017) established the impact of fiscal and monetary policy in case of Rwanda. They have taken quarterly data from 1996 to 2014 and applied recursive VAR.…”