The Impacts of Fiscal Policy Shocks

The use of Vector Autoregressive (VAR) models in macroeconomic analysis has increased greatly over the years with most studies concentrating on developed countries. Very few studies in developing countries have been done so far. In Zimbabwe for instance, a general equilibrium (GE) model has been applied to determine the link between fiscal policy and macroeconomic variables (see Fagernas, 1998). Despite its internal consistency the GE model fails to provide an exact closed form solution thus paving way for other models of analysis. This book therefore applies the five variable VAR model to Zimbabwe. The model allows the fiscal variables to interact as endogenous variables and is run using annual time series data from 1980-2008. Our findings from the impulse response functions suggest that positive innovations to government expenditures increase output with statistical significance with no change to private consumption and investment. Positive shocks to government revenue only increase output in the first two periods. Fiscal authorities should thus engage in productive government expenditures and review the current distortionary tax rates to steer the economy in the right direction.