An empirical study on the dynamic effects of fiscal shock on the economy of Papua New Guinea

The recent global recession has renewed interest in empirical studies on the effects of fiscal shocks. Ramey and Shaprio (1998) defined “fiscal shock” as an unpredicted increase in government spending caused by events that are exogenous to changes in the business cycle. Since its independence in 1975, Papua New Guinea (PNG) experienced several unanticipated events that triggered sudden increases in government spending, but there is no evidence of research done on it. Thus, this thesis aims to investigate the effect of non-systematic discretionary government spending measures on the output of PNG. The empirical analysis will provide estimates of government spending multipliers at different time horizons to assess the efficacy of government spending policies in stabilizing domestic output. My empirical approach adopts the Structural Vector Autoregressive. The analysis finds that the government spending impact multiplier is 0.06, and the cumulative multiplier after the fourth quarter is 0.21. The cumulative multiplier indicates that it takes at least five years for the increment in GDP to exceed the cumulative expenditure shock. The empirical results drawn from this study suggest that government spending has not been highly effective in stabilizing output in the short run.