The impact of fiscal policy on economic growth an analysis for the Maltese islands

Abstract

In this study a vector autoregression was employed to study the impact which discrete changes in fiscal policy (government expenditure and tax revenue) have on economic growth for the Maltese Islands. The endogenous variables used were; real GDP, the GDP Deflator Inflation Rate, the Short-Term Interest Rate, Government Spending and Net Taxes. The impulse response functions were then separately analysed, with the order in which the shock enters the system defined using Cholesky decomposition. Following the shock to government spending, real output increased while the inflation rate increased by a small amount. Taxes were forced to increase and the short-term interest rate responded with an immediate increase. Following the tax revenue shock, government spending increased whilst real output’s response to the shock was slightly negative. Immediately after the shock, inflation responded negatively and the short-term interest rate was neutral to the tax revenue shock. Although the resulting effects of both shocks are in line with economic theory, these results were for the most part statistically insignificant. Although we do not fully believe that fiscal policy has no effect at all on economic growth, the impacts may not be very large.