The Impact of fiscal and monetary policies on economic growth and stability in Tanzania

Abstract

The study analyzed the impact of fiscal and monetary policies on economic growth and stability in Tanzania. The study questioned mechanisms that make one policy more effective than the other and traced efficient way of using these policies; which most prior empirical works did not mention. The study filled this gap in literature by analyzing fiscal adjustments of revenue and spending; comparing effects of money supply and interest rate; and finally deriving an optimal policy – mix. The study used time series data drawn from Bank of Tanzania, World Bank and International Monetary Fund. After the preliminary tests for unit roots and co-integration, the Johansen (ML) procedure was used to jointly estimate co-integrating vectors and error correction model. The study reveals that government spending on physical investment enhances growth and stability; government spending on human capital bolters growth but reduces stability; government spending on consumption retards growth and weakens stability. Also, the study found that government revenue positively relates to growth and stability. It is also evident that while external borrowing enhances growth, internal borrowing reduces it. Moreover, the results show that changes in money supply and interest rates have impact on growth and stability. But, interest rate has more predictable impact than money supply. Furthermore, the study reveals that fiscal and monetary policies affect growth and stability. But, fiscal policy is more effective than monetary policy. Finally, the study found that expansion policy - mix is optimal for Tanzania. To spur growth and stability government has to spend more on investments than consumptions. Also, government has to increase revenue (tax and non-tax) collection. In case of budget deficit, government revenues should be complemented by concessional external borrowing rather than internal borrowing and tied grants. Moreover, BOT has to adopt interest rate based framework instead of monetary aggregate framework. This should go along with widening and stabilizing financial market. Furthermore, government and BOT have to implement fiscal expansion and monetary expansion, respectively. The crossed fiscal and monetary policies cannot ensure growth and stability because monetary policy cannot absorb side effects of fiscal policy in Tanzania.