The Impact of Fiscal Policy on the Output and Inflation

Abstract

This study examines the impact of fiscal policy on output and inflation, along with a look at discretionary fiscal policy and how it impacts the volatility of output and inflation. Model Vector Error Correction Model (VECM) was applied over quarterly data, covering the period 1990 to 2009. Empirical results showed that there is a cointegration relationship between government spending and taxes with respect to output in the long-run.Unlike government spending, in the long-term, taxation has a positive effect on economic growth. Short-term adjustment suggests that anincrease in government spending has a positive effect on output, while a tax increase has a negative effect. There is a greater influence of government spending on output in the short term compared to taxation policies. Therefore, government spending is more effective to stimulate economic growth especially in times of recession, compared to taxation policies. While the increase in government spending causes a decrease in inflation, tax increases lead to higher inflation. This study also indicates the absence of discretionary fiscal policy made by the government of Indonesia. Keywords : Inflation, output, fiscal policy, tax, discretionary, VECM.JEL Classification: E31, E62

The Credibility of Fiscal Rules Policy and Business Cycle Volatility

“…However, Abdurohman (2013) shows that fiscal policy tends to be pro-cyclical. Surjaningsih et al (2012) conclude that the discretionary fiscal policy was not present during 1990-2009. More recently, Kuncoro (2014) observes that the credible fiscal policy has a strong impact on government expenditure volatility.…”

“…Empirically, this yield challenges to the finding of Fatás and Mihov (2006) and Badinger (2009) pointing out that the aggressive use of discretionary fiscal policy induces macroeconomic instability. The pro-cyclical and the absence of discretionary fiscal policy as found by Abdurohman (2013) and Surjaningsih et al (2012) respectively could be a source of explanation.…”

Tax counterbalancing in developing countries the case of Indonesia

“…In the case of Indonesia, the related studies concerning the macroeconomic impact of tax rates policy are limited. In relation to fiscal austerity, Surjaningsih, Utari, and Trisnanto (2012) concluded that government spending is more effective to stimulate economic growth especially in times of recession, compared to taxation policies. In contrast, Basri and Rahardja (2011) argued that tax cut remains being effective to stimulate short-term economic growth particularly in the recession periods.…”

Does the sustainable fiscal policy foster its credibility?

“…At the national level, Surjaningsih, Utari, & Trisnanto (2012) conclude that the absence of discretionary fiscal policy made by the government. Kuncoro (2014) investigates the impact of fiscal policy credibility on its volatility.…”

“…First, since Abdullah et al (2011) take the case of local government, their conclusion does not reflect the credibility of national fiscal policy. Second, Surjaningsih et al (2012) did not explore further the role of fiscal rule in their work. Third, refer to Kuncoro (2014), the more comprehensive approach is needed to reassess the source of non credible deficit rule policy in the case of Indonesia.…”