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


  • Pedro M G Martins


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.

Suggested Citation

  • Pedro M G Martins, "undated". "Fiscal Dynamics in Ethiopia: A Cointegrated VAR Model with Quarterly Data," Discussion Papers 10/05, University of Nottingham, CREDIT.
  • Handle: RePEc:not:notcre:10/05

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    References listed on IDEAS

    1. Mumtaz Hussain & Andrew Berg & Shekhar Aiyar, 2009. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Review of Development Economics, Wiley Blackwell, vol. 13(s1), pages 491-509, August.
    2. Heller, Peter S, 1975. "A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation," American Economic Review, American Economic Association, vol. 65(3), pages 429-445, June.
    3. Mosley, Paul & Hudson, John & Horrell, Sara, 1987. "Aid, the Public Sector and the Market in Less Developed Countries," Economic Journal, Royal Economic Society, vol. 97(387), pages 616-641, September.
    4. Svend Hylleberg, 2006. "Seasonal Adjustment," Economics Working Papers 2006-04, Department of Economics and Business Economics, Aarhus University.
    5. Johansen, Soren, 2002. "A small sample correction for tests of hypotheses on the cointegrating vectors," Journal of Econometrics, Elsevier, vol. 111(2), pages 195-221, December.
    6. Hassler Uwe & Demetrescu Matei, 2005. "Spurious Persistence and Unit Roots due to Seasonal Differencing: The Case of Inflation Rates / Künstliche Persistenz und Einheitswurzeln infolge saisonaler Differenzen: Das Beispiel Inflationsraten," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 225(4), pages 413-426, August.
    7. Robert Osei & Oliver Morrissey & Tim Lloyd, 2005. "The fiscal effects of aid in Ghana," Journal of International Development, John Wiley & Sons, Ltd., vol. 17(8), pages 1037-1053.
    8. 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, vol. 53(1-3), pages 211-244.
    9. Peter Kennedy, 2003. "A Guide to Econometrics, 5th Edition," MIT Press Books, The MIT Press, edition 5, volume 1, number 026261183x, January.
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