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Fiscal Dynamics in Ethiopia: A Cointegrated VAR Model with Quarterly Data

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  • Pedro M G Martins
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    Abstract

    This paper uses the cointegrated vector autoregressive (CVAR) model to assess the dynamic relationship between foreign aid inflows, public expenditure, revenue and domestic borrowing in Ethiopia. It departs from the existing literature by using a unique quarterly fiscal dataset (1993-2008) and providing new insights into the formulation of testable fiscal hypotheses. The paper also derives and interprets structural shocks and places a strong focus on model specification. The results suggest the presence of three long-run relationships: the government budget constraint, a donor disbursement rule, and a financing trade-off. Foreign aid grants adjust to the level of development spending, which can be seen as an indication of (procyclical) aid conditionality. Moreover, domestic borrowing often compensates for lower levels of revenue and grants, highlighting the cost of aid unpredictability and revenue volatility. The policy implication is that if foreign aid flows are to be made more effective, they should be provided in a predictable and countercyclical fashion in order to smooth exogenous shocks.

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    Bibliographic Info

    Paper provided by University of Nottingham, CREDIT in its series Discussion Papers with number 10/05.

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    Handle: RePEc:not:notcre:10/05

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    Keywords: Fiscal Response; Foreign Aid; Time Series Models; Africa.;

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    1. Svend Hylleberg, 2006. "Seasonal Adjustment," Economics Working Papers, School of Economics and Management, University of Aarhus 2006-04, School of Economics and Management, University of Aarhus.
    2. Uwe Hassler & Matei Demetrescu, 2005. "Spurious Persistence and Unit Roots due to Seasonal Differencing: The Case of Inflation Rates," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), Justus-Liebig University Giessen, Department of Statistics and Economics, Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 225(4), pages 413-426, July.
    3. Aiyar, Shekhar & Berg, Andrew & Hussain, Mumtaz, 2008. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Working Paper Series, World Institute for Development Economic Research (UNU-WIDER) RP2008/79, World Institute for Development Economic Research (UNU-WIDER).
    4. Mosley, Paul & Hudson, John & Horrell, Sara, 1987. "Aid, the Public Sector and the Market in Less Developed Countries," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 97(387), pages 616-41, September.
    5. Robert Osei & Oliver Morrissey & Tim Lloyd, 2005. "The fiscal effects of aid in Ghana," Journal of International Development, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 17(8), pages 1037-1053.
    6. Peter Kennedy, 2003. "A Guide to Econometrics, 5th Edition," MIT Press Books, The MIT Press, The MIT Press, edition 5, volume 1, number 026261183x, December.
    7. Heller, Peter S, 1975. "A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation," American Economic Review, American Economic Association, American Economic Association, vol. 65(3), pages 429-45, June.
    8. Johansen, S., 1999. "A Small Sample Correction for Tests of Hypotheses on the Cointegrating Vectors," Economics Working Papers, European University Institute eco99/9, European University Institute.
    9. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, Elsevier, vol. 53(1-3), pages 211-244.
    10. Ndulu,Benno J. & O'Connell,Stephen A. & Bates,Robert H. & Collier,Paul & Soludo,Chukwuma C., 2009. "The Political Economy of Economic Growth in Africa, 1960–2000," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521127752.
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