Sustainability of Fiscal Policy and Government Revenue-Expenditure Nexus: The Experience of Indonesia

This paper empirically examines the issue of fiscal policy sustainability in Indonesia. To do so, we first diagnose the Indonesia’s public finance by analysing the evolution of key fiscal indicators—debt, budget deficit, revenue and expenditure—over time. It is found that the fiscal policy in Indonesia has been responsible and conservative. The budget deficit has been maintained below 3 percent of GDP with a decreasing trend in public debt-to-GDP ratio since 2001 to present. We then test the fiscal sustainability based on the government intertemporal budget constraint (IBC) framework using the data set covering the period of 1982 – 2010. The IBC framework requires the stationarity of public debt and total deficit as well as cointegration of government revenues and expenditures. We find that all the variables of interest are stationary, which favouring a conclusion that fiscal policy in Indonesia has been sustainable during the sample period. We proceed by analysing the nexus of the government revenue and expenditure. The results from the Granger causality test and the generalised impulse response function are consistent with the Friedman’s (1978) tax-and-spend hypothesis, that government revenue Granger causes government expenditure positively. We also find that a shock in expenditure lead to a worsening budget deficit Therefore, in controlling budget deficit and sustaining fiscal sustainability, the fiscal authorities in Indonesia should pursue robust fiscal policy aimed at raising revenue and controlling expenditure.