Asymmetric Effects of Fiscal Deficit on Monetary Policy Transmission in Tanzania

Abstract

This study seeks to investigate the asymmetric effects of fiscal deficit on monetary policy transmission in Tanzania by using quarterly time series data for the period 2001: I to 2019: IV. In the analysis, which is based on the theory of sovereign risk premium, use is made of the asymmetric cointegration modelling in a non-linear autoregressive distributed lag model to distinguish the effects of fiscal deficit on interest rates, exchange rates and inflation. The findings indicate that interest rate and exchange rate react differently to negative and positive changes in fiscal deficit over the long run, and, inflation responds differently to such changes over the long run and short run period. The findings also revealed that interest rate is more sensitive to the worsening in fiscal deficit; and, accordingly fiscal consolidation is an essential requirement for effective transmission of the monetary policy. In particular, implementation of the price based policy framework in Tanzania should be considered carefully, as persistent rise in budget deficits would eventually counter the effectiveness of monetary policy by keeping market interest rates and inflation at high levels. The findings provide evidence in favour of a fiscal policy to stabilise monetary policy variables, but also highlights the importance of long-term fiscal sustainability for the attainment of monetary policy objectives.