Do Fiscal Policy Variables Drive Inflation in the Same Direction?
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Evidence in this chapter establishes different effects between total tax revenue and final consumption expenditure by government. We find similar effects between taxes on income and tax on goods and services. GDP growth declines more when total taxes are not shut off than when they are shut off. What about the role of the fuel levy and VAT on GDP growth and monetary policy tightening shocks? GDP declines more when the fuel levy and VAT are not shut off than when they are shut off. Evidence suggest that taxes on income, tax on goods and services, increased fuel levy and VAT accentuate the effects on monetary policy tightening shocks on the decline in GDP growth. Evidence indicates that since 2013 the counterfactual inflation rate exceeded the actual inflation suggesting the dominance of final consumption by government over total tax revenue.
Nonetheless, evidence shows that monetary policy is tightened by increasing the repo rate to curb inflationary pressures irrespective of developments in the tax components. But, the degree to which repo rate rises varies given differing amplifying abilities of the tax components.
KeywordsMonetary Policy Fiscal Policy Government Spending Final Consumption Monetary Policy Shock
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