Non-Linear Impact of Public Debt on Inflation in Rwanda

Abstract This paper examines Rwanda’s debt-inflation dynamics and the asymmetric effect of government debt on inflation using time series data spanning the years 1980–2021. The study applied a battery of tests to examine the debt-inflation linkage in this country, including the bounds F-test for cointegration, the Brock-Dechert-Scheinkman (BDS) nonlinearity test, the Wald test for asymmetries and the nonlinear autoregressive distributed lag (NARDL) model for short run and long run asymmetric impact. The results of the NARDL bounds F-test for cointegration support a long-run nonlinear link between public debt and inflation in Rwanda. The findings of the BDS test reveal that the series is nonlinear in all dimensions, whereas the results of the Wald test show that public debt has an asymmetric impact on inflation, regardless of the timescale considered. The NARDL findings show that while a rise in public debt tends to be inflationary in the short run, a decline in public debt typically leads to a decrease in inflation in the long run. The study also demonstrates that inflation responds more rapidly and strongly to positive than negative shocks in public debt. The country should think about continuous enforcement of fiscal consolidation measures and reforms, as well as implementing economic growth-friendly policies to reduce debt increases in the short run. This will induce a decline in inflation and enhance macroeconomic stability in the long run.