The Relevance of an Optimal Policy Mix in the CEMAC zone

By Jean C. Kouam & Simplice A. Asongu

The Relevance of an Optimal Policy Mix in the CEMAC zone (Download full article)

Abstract

The study analyses the nature of the nexus between budget deficit and economic growth given inflation trends. It focuses on data from the six CEMAC countries for the period 2000 to 2021. The employs unit root tests and the generalized method of moments (GMM) for the empirical
evidence. The following results are established: (i) the level of inflation above and below which the nexus between budget deficit and economic growth changes sign is about 1.8%. (ii) Below this threshold, each 1% decrease in budget deficit induces an increase in economic growth of about 0.30%; but above the threshold, economic growth decreases by 1 % when budget deficit increases by 0.08%. In view of the war in Ukraine and the global economic situation, which require countries to take adequate measures to strengthen the resilience of their economies, including through high–impact economic activities, any national policy aimed at reducing the budget deficit should be preceded by the reduction of inflation to below 1.8%. Otherwise, any measures put in place by the monetary authorities to stabilize prices would not have the expected effect on economic growth and would hence, be counterproductive. In terms of theoretical underpinnings, at the inflation threshold, the findings are consistent with the “Ricardian equivalence” theorem on the absence of any tangible incidence of budget deficits on economic prosperity while above (below) the inflation threshold, the findings are in line with neoclassical economists (Keynesian perspective) on a negative (positive) linkage between budget deficits and economic growth. This study complements the extant studies by providing thresholds at which budget deficit affects economic growth.

Keywords: CEMAC, Inflation, Economic growth, Budget deficits, Non–linear effects
JEL Classification: E23; F21; F30; L96; O55

1. Introduction

The present exposition is motivated by two fundamental points in the extant policy and scholarly literature on the subject, notably: (i) conflicting strands in the literature on the importance of budget deficits in economic prosperity and (ii) gaps in the extant economic growth literature.
These fundamental elements are substantiated in the same chronological order as highlighted.

First, consistent with the extant literature on the subject (Van & Sudhipongpracha, 2015), the incidence of government deficits is a relevant economic concern that is confronting policy makers in both developed and developing countries (Vuyyuri & Seshaiah, 2014). According to the narrative, about ten decades ago, governments were associated with substantial deficits, especially in times of economic depressions or wars. However, over past few decades, governments have incurred substantial deficits to finance programs of social welfare and healthcare instead (Tanzi & Schuknecht, 1997). In the attendant macroeconomic literature, a bulk of empirical and theoretical studies has focused on the nexus between macroeconomic variables (i.e. employment and economic prosperity) and budget deficits. Still, perspectives are conflicting on studies focusing on the importance of budget deficits in the expansion of economies (Elmendorf & Mankiw, 1999). From a neoclassical angle, while in the short term, current consumption is increased by budget deficits, corresponding private investment is reduced in the long term. However, according to Keynesian economists, a “crowding–in” impact is apparent in which a nation’s production at the domestic level increases owing of government deficit spending which in turn, provides incentives for more business investments. Conversely, contrary to the Keynesian and neoclassical perspectives, the theory of Ricardian equivalence posits that macroeconomic conditions are not affected by government deficits.

Second, the contemporary extant CEMAC–centric literature on economic growth in the literature has largely focused on inter alia: the nexus between external debt and economic growth (Nouamo et al., 2020); an assessment of fundamental drivers of economic performance in the region (Sundjo et al., 2018); the incidence of common currency on economic prosperity (Kangami & Akinkugbe, 2019); the relevance of institutional quality in economic prosperity (Seppo, 2020); the combined incidence of private and public investments in economic growth (Noula et al., 2020); the nexus between foreign investment and economic growth (Sindze et al.,2021); the connection between financial inclusion and economic growth (Kamga et al., 2022); short and long term money policy dynamics in relation of economic growth and price volatility (Olamide et al., 2021) and the importance of trade openness in economic prosperity (Kuikeu, 2022).

The present article seeks to complement the extant literature by assessing the nexus between budget deficit and economic growth, contingent on inflation in the Economic and Monetary Community of Central Africa (CEMAC) made-up of six states: Gabon, Cameroon, Central African Republic (CAR), Chad, Republic of Congo and Equatorial Guinea. The positioning also departs from the extant non-contemporary literature which has focused on inter alia, how government deficit tackles the incidence of government expenditure on decisions related to private investments (Yellen, 1989; Barro, 1990); monetary and financial views on the incidence of budget deficits on economic prosperity with emphasis on exchange rate (Hakkio, 1996; Stoker, 1999), inflation (Smyth & Hsing, 1995) and fiscal management (Antwi et al., 2013).

In terms of theoretical underpinnings, three main views are apparent in the extant literature (Van & Sudhipongpracha, 2015), notably: the Keynesian, Noeclassical and the Ricardian equivalence theorem. These theoretical premises are expanded in what follows in the same chronology. (i) According to the Keynesian view, there are “crowding-in” or expansionary incidences of budget deficits in the economy owing to improvements in private investment and domestic production (Modigliani, 1995) or the positive relevance of deficits on economic growth (Coggington, 1976). In essence, government budget deficit improves aggregate demand which ultimately increases private investment and savings (Eisner, 1989). The attendant crowding-in incidences are apparent when budgets deficits engender public infrastructure (Carlsson et al., 2013), not least, because education and social welfare programs improve technological and human capital and by extension, mitigate social conflicts (Kelly, 1997).

(ii) The neoclassical economists dispute that “crowding-in” incidences are only apparent in the short term, not least, because tax burdens are shifted to the future by the government when
budget deficits are taken into account (Bernheim, 1989). Hence, as a consequence, savings are likely to decline even though current private consumption has to increase. Within this remit, interest rates are anticipated to increase in order for the equilibrium in the capital market to be
restored. Higher rates would engender less private investments (Plosser, 1982). As Buiter (1977) 5 maintains, according to neoclassical economists, negative ramifications such as budget deficits “financial crowding-out” are apparent which reduces the ability of the government to influence economic development by means of fiscal policies. Beyond, the consideration of financial consequences, government deficits can also be the origin of “resource crowding-out”, especially when government deficit spending is related to relevant economic resources that are essential for private domestic investment to thrive.

(iii) Whereas Neoclassical and Keynesian economists provide views that are contradictory on the nexus between budget deficits and economic growth, a “Ricardian equivalence” theorem is proposed by Barro who has posited that the nexus is neutral (Barro, 1989). When budget deficits increase in the contemporary era, it is relevant to compensate these with potential increases in tax, hence consumption of private nature and interest rate are unaffected according to Cunningham and Vilasuso (1994). For instance, the findings of Barro (1990) show that spending programs of the government have no direct incidence on productivity at the economic level. Instead, the type of government program and service is what affects the attendant deficit-growth linkage. According to Barro (1991), public infrastructure spending can engender more positive economic outcomes relative to agricultural subsidies and programs of welfare. Bose et al. (2007) maintain that long term economic impacts can be apparent when budget deficits are traceable to the education sector.

The rest of the study is structured in the following manner. The data and methodology are covered in Section 2. The empirical results are disclosed in Section 3 while Section 4 concludes with policy implications and future research directions.