The Nexus Between Inflation And Fiscal Deficit In Kenya

Abstract

This study investigates the connection between fiscal deficit and inflation in Kenya. It also checks for structural breaks, causality between the two variables and their form of association. To achieve these objectives, it adopts ARDL-Cointegration Approach, Granger Causality test, and also considers Nonlinear ARDL model, using annual time series data for thirty-nine years, 1980 - 2018. The results show that the first lag of fiscal deficit has a negative and significant effect on inflation, while its second lag is insignificant. Granger causality results show that there is no causality between fiscal deficit and inflation in Kenya. All the control variables used i.e. lagged values of inflation, real interest rate, broad money supply, real GDP, trade openness and exchange rate were statistically significant at least in one of their lags. However, real interest rate and exchange rate gave unexpected signs.