THE IMPACT OF FISCAL POLICY ON THE OUTPUT AND INFLATION

Abstract

This study examines the impact of fiscal policy on output and inflation, along with a look at discretionary fiscal policy and how it impacts the volatility of output and inflation. Model Vector Error Correction Model (VECM) was applied over quarterly data, covering the period 1990 to 2009. Empirical results showed that there is a cointegration relationship between government spending and taxes with respect to output in the long-run.Unlike government spending, in the long-term, taxation has a positive effect on economic growth. Short-term adjustment suggests that anincrease in government spending has a positive effect on output, while a tax increase has a negative effect. There is a greater influence of government spending on output in the short term compared to taxation policies. Therefore, government spending is more effective to stimulate economic growth especially in times of recession, compared to taxation policies. While the increase in government spending causes a decrease in inflation, tax increases lead to higher inflation. This study also indicates the absence of discretionary fiscal policy made by the government of Indonesia. Keywords : Inflation, output, fiscal policy, tax, discretionary, VECM.JEL Classification: E31, E62

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