Fiscal policy in times of high debt: tale of Lebanon

ABSTRACT This study empirically identifies fiscal shocks and traces their effect on GDP and its components using structural VAR framework in a highly indebted economy of Lebanon. Empirical findings of this study point to an inefficiency of fiscal policy in stimulating economic activities, stipulating that fiscal policy is conducted with non-Keynesian features. Government expenditure multiplier exhibits near zero effect with magnitude of 0.068 on impact and insignificant otherwise. Also, we document evidence in favor of crowding out effect given central government's borrowings are mainly from the local financial market. Policy implication of this paper is twofold. First, given a non-Keynesian effect of fiscal policy, policy makers should refrain from using fiscal tools to counteract business-cycle fluctuations. Second, in order to break through government expenditure inefficiency, government officials must curb a rising budget deficits to harness an increasing cost of capital and, therefore, impeding potential growth of private sector. Previous fiscal policy practice has invoked concerns about sustainability of public debt time path and triggered a sovereign crisis which has been translated into a BOP crisis.