Fiscal policy and macroeconomic variables: the case of Thailand

Abstract

Fiscal policy in Thailand was expansionary after the 1997 financial crisis until 2002. The public debt rapidly increased from just below 15% of gross domestic product (GDP) in 1996 to 58% in 2000, which is only just below the fiscal sustainability framework target of 60%. Although debt had been reduced to 34% by 2006, since 2007 the government has again run budget deficits and spending has grown twice as fast as revenue. The public debt has exceeded 40% of GDP again. This indicates that the effectiveness of current fiscal policy needs to be questioned. This study investigates the effect of changes in tax and government spending on GDP, price level, the interest rate, private consumption and private investment. Previous studies on the effects of fiscal policy in Thailand have employed macroeconomic models with Simultaneous Equation Methodology (SEM). This has the advantage of having no limit on the number of variables to be explained, but, because of its size, many restrictions are required that may be theoretically controversial or even contradictory. Moreover, SEM is unsuitable for policy evaluation because the structure it describes may change as a result of policy changes. The present study employs the less restrictive Vector Auto-Regression (VAR) modelling framework, which uses the Vector Error Correction Model (VECM) to account for non-stationarity in data and also employs impulse response functions (IRFs) to examine the dynamic properties. In this study, a VECM is run for the period 1988:1–2009:4, and the IRFs for a shock from government expenditure and from taxation are examined. According to the model, a positive shock of 1 baht of total government spending and of capital spending increases GDP by a maximum of 0.17 and 0.60 baht, respectively. The effects on both the interest rate and the price level are also positive. In terms of current spending, an expansionary shock has a brief positive (though insignificant) impact on output, before a negative impact occurs after three quarters. A total tax increase has a positive impact on output in the first five quarters, but the impact then becomes negative. An increase in personal income tax has a positive impact on output, an indirect tax increase has a negative impact on output, and the impact of corporate income tax on output is insignificant. If the government of Thailand wishes to increase the effectiveness of its expansionary fiscal policy, it should focus on increasing the ratio of capital spending to total government spending, which is just 20% at present, because the multiplier of capital spending is larger than the multiplier of current spending.