A Cointegration and Causality Analysis of Fiscal Deficits and Macroeconomic Variables

Deficits impact major macroeconomic variables such as money supply, interest rates, consumption-public and private, investment and growth. With the State increasingly being viewed as a welfare state, this relationship between fiscal deficits and macroeconomic variables is becoming very evident particularly in developing countries. This paper attempts to examine the relationship between fiscal deficits and the macroeconomic variables employing the cointegration and the causality technique for 1952-53 to 1996-97. Cointegration is first employed to test whether a long run equilibrium relation exists between deficits and the variables. Bivariate causality lests using Hsiao 's Method and in the Granger-Modified Sims framework were conducted for the cointegrated variables. Our results indicate unidirectional causality from the macroeconomic variables to the fiscal deficit and indicate bi-directional causality for the Government Bond Yield Rate. Instantaneous Causality is also observed for three of our five variables.