Fiscal Aggregates, Aid and Growth in Kenya: A Vector Autoregressive (VAR) Analysis

Theoretical predictions and empirical evidence on the impact of foreign aid and fiscal policy on growth are mixed. This paper examines the effect of fiscal variables (government expenditure and revenue) and aid on growth using annual time series data for Kenya over the period 1964 – 2002. Multivariate cointegration (VAR) and vector error correction models (VECM) are estimated to establish both the shortand longrun relationships between foreign aid, fiscal variables and growth of per capita income. Two measures of aid are used; external grants and loans, and both yield different results. Aid loans are found to have a negative impact on long run growth whilst grants have a positive one. Government spending is found to have a positive long-run influence on growth, and there is no evidence that taxes retard growth. The implication for policy is that aid to Kenya could be more effective if given in form of grants, and associated with fiscal discipline. Outline