Effect of Selected Macroeconomic Variables on Budget Deficit in Kenya

Abstract

Macroeconomic stability has been a concern to many economies as it shows the economic health of a nation. Kenya has had unsustainable and persistent fiscal deficit which has been phenomenal in the recent past despite several economic reforms being established in an attempt to stabilizing the economy. The study was informed by the persistent increase in the budget deficit in Kenya amidst economic stagnation and macroeconomic instability. This therefore led to an attempt to establish the effect of selected macroeconomic variables on the budget deficit in Kenya. The specific objectives were to determine the effect of interest rates; exchange rate; inflation and money supply on budget deficit in Kenya. The study sought to evaluate the significant effect of the selected macroeconomic variables on budget deficit in order to formulate the policy consideration to the economic problem. The study was guided by the Keynesian which was the main theory of the study. The Mundell-Fleming and Ricardian Equivalence theories were also employed as addition theories to back up the study. The study methodology was based on an explanatory design for time series data covering 30 years from 1991 to 2020. Autoregressive distributed lag error correction model (ARDL) estimation was adopted to analyze and infer results of the study. The CUSUM model stability test indicated that the model was stable and the model coefficient was reliable. Diagnostic test results showed there was no autocorrelation (p=0.1510>2.062), no heteroscedasticity (p=0.0903>21.47), and there was no multicollinearity (vif=1.34). Shapiro wilk normality test indicated that the variables of the study were normally distributed. The ADF unit root test indicated that there was unit root and co-integration test confirmed that the variables had a long run relationship. The findings of the study were: interest rate had a positive significant effect on budget deficit in the long run ( β_1=0.0404, <0.05); exchange rate had a positive significant effect on budget deficit ( β_2=0.4189, <0.05); inflation had a negative insignificant effect on budget deficit ( β_3=-0.001, >0.05). Money supply had a positive insignificant effect on Budget deficit ( β_4=0.00004, >0.05). The ARDL long-run results showed that the explanatory variables had Adjusted R2=0.4666 impact on the budget deficit and an F-statistics of 135.5802. The study therefore concluded that interest rate had a positive effect on the budget deficit in the long run. Increasing interest rates in the economy ends up driving budget deficit upwards in the long run. The same was true when the variable of concern is exchange rate. The study findings recommend that there is need for the government to ensure there is stability in macroeconomic variables. This is because there was a significant link between the budget deficit and the selected macroeconomic variables. A strive by the government to reduce budget deficit would mean an adjustment in macroeconomic variables to suit the purpose. These adjustments may include reducing the interest rate in the economy. A reduction in the interest rates in the economy would end up reducing the budget deficit.