Asymmetric effects of fiscal policy on inflation in Kenya

This study investigates the asymmetric effects of fiscal policy on inflation (INF) in Kenya using data for the period from 1991 to 2021. The study differs from previous studies by applying the non-linear autoregressive distributed lag (NARDL) modeling to capture asymmetric dynamics. The study identified a long-run equilibrium and cointegrating relationship among the study variables, with the findings indicating the existence of asymmetric long-run effects of public debt (PD) and government spending (GS) on INF. A positive relationship between increases in PD and INF in the short-run is also established, while decreases in PD are found to increase INF in both the long-run and short-run. Increases in GS raise INF, while decreases in tax revenue (TR) reduce INF in the long-run. Output gap has a persistent positive relationship with INF, while interest rate negatively affects INF. As such, the study recommends that policymakers should prioritize fiscal measures, especially government expenditure by ensuring that any additional spending does not cause inflationary pressures. The government should also regulate PD by ensuring that its levels align with the objective of INF control.Governments use fiscal policy tools such as spending and taxation to influence macroeconomic performance. However, Kenya’s government has been unable to maintain a sustainable fiscal policy due to an imbalance between government expenditures and revenues. In recent years, government spending has consistently exceeded its revenues, resulting in the need to borrow in order to finance its fiscal targets, creating a burden of debt accumulation. This has made it more difficult to finance essential public services and hindered the achievement of the medium term plan’s (MTPs) targets for the realization of the Kenya’s Vision 2030. This study examines the asymmetric effects of fiscal policy on inflation in Kenya using the non-linear autoregressive distributed lag (NARDL) modelling to provide a better understanding of Kenya’s inflation. This helps to inform the policymakers on decision making and careful approach to the fiscal policy strategies.