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Short- and long-run growth effects of fiscal policy in Bangladesh

Author

Listed:
  • Sultan Hafeez Rahman

    (BRAC University)

  • Muhammad Shahadat Hossain Siddiquee

    (BRAC University
    University of Dhaka)

Abstract

The potential interactions between government expenditure, taxation and growth are complex and manifold and thus, it gives rise to a constant debate about the growth-effectiveness of the fiscal policy, especially in developing countries like Bangladesh. Despite such a debate between fiscal policy variables and economic growth, most empirical analyses ignore the complete specification of the budget constraints while using regression approaches. Therefore, they suffer from specification biases due to ignoring complete budget constraints and the bias from the methodological perspective. The main objective is to examine the short- and long-run relationships between fiscal policy variables and economic growth by applying complete budget constraints and advanced estimation techniques (e.g., Autoregressive distributed lag (ARDL) bounds testing approach to cointegration, Error-correction, Johansen Co-integration test and the Granger causality test) and using more recent and a wider span of time period 1976–2019. Both the ARDL approach to cointegration and the error-correction (ECT) coefficients confirm the existence of a stable long-run relationship between economic growth and fiscal variables. The ECT results also confirm that the disequilibrium for the GDP equation converges if any shock occurs in the short-run. Johansen’s trace and maximum eigenvalue statistics prove the existence of cointegrating vectors, which is consistent with the Bounds testing approach and thus, the results are robust. Results using the Granger causality test show that direct tax has two-way causal relationships with economic growth whereas indirect tax and revenue expenditure has a unidirectional relationship with GDP in the short-run. In the long-run, indirect tax has a negative effect and revenue expenditure and fiscal deficit exert positive effects on growth. Based on empirical findings, this study indicates the importance of collecting more direct tax as it guarantees higher growth through financing the revenue expenditure and improves equity of taxation due to the progressive nature of the direct tax.

Suggested Citation

  • Sultan Hafeez Rahman & Muhammad Shahadat Hossain Siddiquee, 2022. "Short- and long-run growth effects of fiscal policy in Bangladesh," SN Business & Economics, Springer, vol. 2(9), pages 1-21, September.
    • Handle: RePEc:spr:snbeco:v:2:y:2022:i:9:d:10.1007_s43546-022-00326-y
    DOI: 10.1007/s43546-022-00326-y
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