Budget deficit-macroeconomic variables nexus in Kenya

Aim/purpose - The aim of this paper was to establish the nexus between a budget deficit and selected macroeconomic variables in Kenya. This adds to the existing literature while the methodology and choice of the econometric tools used improve the predictability of the link between a budget deficit and macroeconomic variables. The results are relevant to policy makers as they may help improve understanding of budget deficit management. Design/methodology/approach - The study used time series data for the period from 1976 to 2018 and employed the Vector Autoregression model reinforced by the Keynesian Mundell-Fleming framework. Findings - The impulse response function derived from the vector autoregression model revealed that shocks from both interest rate and exchange rate had a positive impact on budget deficit. External debt servicing and current account deficit shocks had a negative impact on the budget deficit. Research implications/limitations - Interest rate and exchange rate policies remain key in reducing the growth of the budget deficit. Policies on external debt servicing, such as timely payment of debts and prudent investment of borrowed funds, will also reduce the budget deficit. Originality/value/contribution - The study employed transmission mechanism which involves multiple equations to establish the nexus between a budget deficit and macroeconomic variables in Kenya.