The Effects of Budget Deficits and Public Debt on Real Interest Rates in Kenya

Abstract

The subject of Public Expenditure, Public Debt and government financing has dominated the social airwaves in Kenya in the recent past. The enshrouding debate that the government is living beyond its means is now almost becoming synonymous with every Kenyan in the street and the households experience in the consumption system. This has now brought a sharp focus to the policy analysts, policy makers and academicians. It is upon this ground that the present study sought to investigate the effects of budget deficit and public debt on real interest rates in Kenya for 37 years (1978-2014). The study adopted yearly data series as the data availability dictated. Focusing on answering two research questions advanced in the maiden chapter of the study, the variables were subjected to unit root test using Phillips-Peron and Augmented Dickey Fuller. The test found out that budget deficit variable was not stationary at level, while all the remaining variables had constant moments at level. This therefore ensured that the only available model of analysis is the ARDL (Autoregressive Distributive Lag). The ARDL model proved signifiant and jointly resulted into a result of all the variables causing real interest rate in Kenya at 76% contribution range. On the other hand, it is interesting that only CPI variable had a significant contribution to Real Interest rate in Kenya in the Long run. This is an interesting bit of this study as the main variables such as Public Debt and Budget Deficit did not reveal to be significant. The reuslt is in contravention with apriori. The results also indicate that the two of the investigated variables have causality running from real interest rate at 5% significance level. Public Debt and GDP growth proved to be caused by Real Interest Rate in the long run.