How do Monetary and Fiscal Policy Shocks Explain Macroeconomic Fluctuations in Africa?

Abstract

This study examines the joint impact of fiscal and monetary policy shocks on some fundamental macroeconomic indicators in three emerging African economies: Ghana, Nigeria and South Africa. The study uses a vector autoregressive (VAR) method with recursive ordering to explain the relationships between the variables over the years 1970 to 2013. The macroeconomic variables considered include real GDP, Inflation and Trade. Granger causality tests are used to determine the causality behavior among the variables. Orthogonal impulse response functions (IRF) and forecast error variance decompositions are then constructed to identify the effects of both fiscal and monetary policy shocks on the macroeconomic variables. The research finds that in general, the impacts of fiscal policy shocks are more pronounced and significant than monetary policy shocks. Over the period, the macroeconomic variables are seen to respond considerably to both contractionary and expansionary fiscal policy shocks. Thus fiscal policy shocks can stimulate economic activity significantly in these countries. The effects of the monetary policy shocks on the other hand are observed to be long term in nature. Contractionary monetary policy shocks are seen to generally reduce the levels of output, which conforms to literature. Overall, our results provide a comprehensive and coherent picture of the joint effect of fiscal and monetary policy shocks on African economies.