




































Economy 
ISSN : 2313-8181 
Vol. 2, No. 1, 16-20, 2015 
www.asianonlinejournals.com/index.php/Economy 

 

 

* Corresponding Author 

 

 

16 

 

Fiscal Sustainability in the Ghanaian Economy: A Fiscal 

Reaction Function Approach 
 

Kugbee S. James
1*

 --- Insah Baba
2
  

 
1
St. Francis Xavier Minor Seminary. Wa, Upper West Region, Ghana 

2
School of Business, Wa Polytechnic, Wa, Upper West Region, Ghana 

 

Abstract 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
This work is licensed under a Creative Commons Attribution 3.0 License 

Asian Online Journal Publishing Group 

 

Contents 
1. Introduction ............................................................................................................................................................................... 17 

2. Literature Review ...................................................................................................................................................................... 17 

3. Theoretical Framework and Methodology ............................................................................................................................. 18 

4. Results and Discussion .............................................................................................................................................................. 18 

5. Conclusion .................................................................................................................................................................................. 20 

References ...................................................................................................................................................................................... 20 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Policy sustainability has been a major concern in Ghana with an increasing debt situation. This 

has led to the Government of Ghana seeking a bailout from the International Monetary fund. The 

objective of this research is to determine the role of budget deficits on the growth of debt. It will also 

evaluate the current fiscal stance on sustainable economic growth. This is achieved by testing a fiscal 

reaction function for the Ghanaian Economy based on the Intertemporal Budget Constraint. The 

estimation was performed using the Ordinary Least Squares (OLS) estimation technique. Stationarity 

test for the variables was conducted using the Augmented Dickey-Fuller Tests. The results point to a 

high degree of inertia present in government behaviour when it sets its primary balance. An increase in 

past primary deficit leads to an increase in current primary deficits. Also increase in debt has a 

significant and positive influence on primary balance. The study thus recommends that government 

should cut down on borrowing to finance its deficits. 
 

Keywords: Primary balance, Debt, Fiscal sustainability, Intertemporal budget constraint, Deficits, Fiscal policy. 
JEL Classification: E60, E61, E62. 

http://creativecommons.org/licenses/by/3.0/


Economy, 2015, 2(1): 16-20 

 

 

 

 

17 

 

1. Introduction 
Sustainability of fiscal policy emerged as a major economic issue in Ghana following the high levels of debt 

experienced in the 1980s. Ghana is ranked among the most Heavily Indebted Poor Countries (HIPC) in the world. 

The country’s high public debt and debt servicing impairs the capacity of the economy to achieve desired growth and 

development. Ghana, like other developing countries, has encountered several fiscal challenges. Observably, the 

level of government spending has been higher than government domestic revenue. The higher spending relative to 

revenue stems from the fact that various governments desire to increase and enhance the socio-economic wellbeing 

of her people. The resulting fiscal deficits have been resolved by both domestic and external financing.  

Further, the domestic financing of the deficits have usually come from banking and non banking sectors. Ghana 

has secured various forms of external financing to supplement domestic sources (Indermit and Brian, 2005). For 

instance, there was an issue of US$ 750 million sovereign bond that Ghana secured in 2007, and that increased 

Ghana's debt. Also, Ghana has obtained loans, both from bilateral and multilateral sources for development. 

Ghana’s total outstanding external debt stock at the end of September 2012 stood at US$7,843.2 million. And 

total outstanding external debt stock at the end of June 2013 stood at US$9,342.9 million and constituted 20.5 per 

cent of GDP (Bank of Ghana, 2013). Total revenue and grants for the year 2011 was GH¢12,851.56 million (22.8% 

of GDP) and total government expenditures amounted to GH¢13,379.98 million (23.8% of GDP).  

The main objective of this study is to determine the role of budget deficits on the growth of debt. It will also 

evaluate the current fiscal stance on sustainable economic growth. 

The rest of the paper is organized as follows: Section two is the literature review. The theoretical framework and 

methodology is in section three. Section four is the discussion of results. Lastly section five is the conclusion to the 

study.  

 

2. Literature Review 
2.1. Intertemporal Budget Constraint 

The literature has proposed several definitions for fiscal sustainability. The requirement that the tax rate should 

not rise forever is one of the first definitions of sustainable fiscal policy. Balassone and Franco (2000) have noted 

that theory has proposed different conditions for sustainability. Employing Domar’s model, they derived a necessary 

condition for sustainability: an ever-growing tax ratio cannot be sustainable. 

Blanchard (1990) noted that sustainability is about whether current fiscal policies of governments leads to 

excessive debt accumulation. Operationalising this, Blanchard defines sustainable fiscal policy as a policy that 

ensures that the ratio of debt to GDP converges back towards its initial level. 

 In a similar vein, Buiter (1985) calls a fiscal policy sustainable if it maintains the ratio of government net worth to 

GDP at the present level. Apart from the statistical point these definitions are essentially the same. By this net worth, 

Buiter explicitly recognises that the government may temporarily keep its gross debt from rising by using its assets to 

finance the deficits.  

 

2.2. Fiscal Rules: Definitions and Application 
Different definitions by different authors have being provided for fiscal rules. Notably, all definitions implied a 

constraint of fiscal policy actions over time (Kopits and Symansky, 1998; Kell, 2001; Buti and Giudice, 2002; 

Milesi-Ferretti, 2003; Drazen, 2004; Kopits, 2004; Siebrits and Calitz, 2004). Several other authors view fiscal rules 

as restrictions on budget deficits, the level of public debt or government expenditure. Differences do exist as to 

whether rules should be permanent or could also include temporary restrictions and whether rules should be 

contained in policy statements or also encoded in law.  

 

2.3. Other Analytical Tools 
As noted, the intertemporal budget constraint is not the only analytical tool available for testing fiscal 

sustainability. A chain of the literature identifies sustainability with the dynamic stability of the public debt/GDP 

ratio around a constant steady state (Masson, 1985; Tobin, 1986; Zee, 1988; Blanchard et al., 1990). This definition 

has a lot more intuitive appeal than the solvency requirement if paths of the public debt/GDP ratios are ruled out. 

Nevertheless, the dynamic stability approach was criticized because of its simplicity. In its simplest form it implies 

that any constant path of the public debt/GDP ratio is sustainable, be it at high or at low levels. 

 

2.4. Fiscal Reaction Functions 
Bohn (2007) proposes a fiscal reaction function approach as favourable to measure fiscal sustainability. He 

asserted that this was backed by economic intuition pointing to studies that follow a fiscal reaction function. Several 

other studies have used this specification to establish a systematic relationship between the primary surplus and 

public debt in the US economy. Bohn (1998) used a multiple regression technique and found that the fiscal 

authorities responded to positive debt dynamics with increases in primary deficit. 

Bohn (1998) found a positive and statistically significant coefficient for the USA in the 20
th
 century and 

concludes that policy-makers eventually reacted to the accumulation of large debt positions over this period of time. 

Employing the same methodology, Wyplosz (2006), Staehr (2008) using European datasets found some evidence of 

a positive feedback from the debt stock to the primary balance. Piergallini and Postigliola (2012) find that the 

primary balance in Italy has exhibited a positive reaction to the debt stock and argue that this suggests that politicians 

have taken corrective measures to ensure the sustainability of public finances in Italy.  

Furthermore, estimating a fiscal reaction function for Brazil using monthly data, De Mello (2008) finds that the 

primary balance reacts positively and strongly to the lagged debt stock. Estimating a Fiscal Reaction Function for 

Greece, Stoica and Leonte (2011) asserted that business cycle and public debt affect fiscal policy variables in a 



Economy, 2015, 2(1): 16-20 

 

 

 

 

18 

 

statistically insignificant manner. They concluded that fiscal policy conduct is a cause of the difficult macroeconomic 

situation facing Greece. 

 

3. Theoretical Framework and Methodology 
3.1. Theoretical Framework               

Fiscal reaction functions can be estimated using historical data, linking primary balance to the stock of debt in 

the previous period, business cycles and random shocks. The resulting feedback parameter is typically of order of 

magnitude of the real rate of interest. Following Bohn (1998), Gali and Perotti (2003), the specification of fiscal 

reaction function is based on the government's intertemporal budget constraint: 

Deficit G T B M                                              (1) 

( , )pb f debt controls          (2) 

( ,inf ,exchange rate )pb f debt lation                (3) 

Where inflation and nominal exchange rate are the control variables. The primary balance denoted by Pb is used 

to represent the deficit. This is to capture the real effects of the deficit.  

In econometric specification, the fiscal reaction function can therefore be estimated by regressing the primary 

balance on the public debt, both defined in percent of GDP while controlling for other determinants of fiscal stance.

 This leads to equation (4) as 

(4) 

   

Where Pb is primary balance, alpha PB(-1) is the inertia, DEBTt-1 is previous years debt, and  INFLt  is inflation 

and EXCt is  exchange rate and t is the error term.    

 

3.2. Data and Methodology 

3.2.1. Description and Sources of Data 
The data used for this study consisted of annual observations. This study will focus on fiscal and macro 

indicators to address national solvency issues. The study considers a period of thirty-two (32) years. The period of 

study will span from 1980 – 2012. Data was gathered from Bank of Ghana, International Finance Statistics (IFS), 

and Ministry of Finance and Economic Planning.  

 

 

3.2.2. Estimation Technique 
The time series property of Ghanaian fiscal variables was examined concentrating on unit root and stationary 

tests. The Eviews 7 software was used. This employs the Augmented Dickey-Fuller Tests. The Ordinary Least 

Squares (OLS) Technique was also used for the research.  

 

4. Results and Discussion 
4.1. Summary Characteristics of Variables 

A survey of the data used indicates that the an average and maximum of debt of 75 percent and 186 percent 

respectively. Primary deficit averaged about 9 percent for the study period. This is shown in table 1. 
 

Table-1. Summary characteristics of variables 

 EXR INF DEBT PB 

 Mean  4855.863  29.55606  75.77576 -9.193076 

 Median  1740.400  24.00000  59.20000 -8.702520 

 Maximum  18800.00  123.0000  186.2000  0.600000 

 Minimum  2.750000  8.720000  22.10000 -22.72368 

 Std. Dev.  5697.718  26.58079  41.49915  6.591897 
                                         Source: Authors’ construct 

 

The economy of Ghana continued to incur debt from the period of this study with the highest debt incurred in the 

year 2000. This shown in figure 1 of panel A. 

The primary balance is expressed as a percentage of GDP to show the portion of government net borrowing on 

its GDP. From the period of this study, government has had a positive primary balance in 2000. The highest negative 

primary balance was 2008 and lowest being 2010. This is shown in figure 2 of panel A. 

Panel A. Trend of debt and primary balance as percentage of GDP 

 

 
Figure-1. Trend of debt as percentage of GDP 

                                    Source: Author’s construct     

0 1 2 1 3 4( 1)t t t t tpb PB DEBT INFL EXC           



Economy, 2015, 2(1): 16-20 

 

 

 

 

19 

 

 
Figure-2. Trend of primary balance as percentage of GDP 

             Source: Authors’ constuct 

 

4.2. Stationarity Characteristics of the Variables 
The output of the unit characteristics using the three tests for stationarity of the variables shows that a good 

number of the variables are non-stationary with intercept capturing the nonzero mean under the null hypothesis. All 

variables are I(1), i.e. first difference stationary. The end result from this is that the variables require differencing for 

non spurious regression results. These are shown in table 2.  

 
 

 Table-2. Results of unit root tests 

 Level First Difference 

 Variable Constant Constant+Trend Constant Constant+Trend 

ADF 

test 

CONSTANT 

PB(-1) 

DEBT 

INFL 

EXC 

-0.203538 

-.539703** 

-4.1809* 

-2.706472 

-3.34828** 

-2.615013 

-5.771691** 

-2.8272 

-2.452627 

-1.019061 

-4.923343* 

-8.861007* 

5.3568* 

-4.283916* 

-3.3876** 

-5.015405* 

-8.720161* 

-6.5331* 

-4.936339* 

-4.597623* 

Phillips-

Perron 

test 

CONSTANT 

PB(-1) 

DEBT 

INFL 

EXC 

0.417881 

-.546394**  

-4.4138** 

-4.745990* 

-6.018198* 

-2.529251 

-6.109341**  

-2.835 

-0.762661 

-0.619586 

-5.032743* 

-25.85766*  

-5.3415* 

-4.271993* 

-3.37753** 

-5.317066* 

-26.00035*  

-10.008* 

-5.213958* 

-4.575915* 

KPSS 

test 

CONSTANT 

PB(-1) 

DEBT 

INFL 

EXC 

0.638315*  

0.235414*  

0.7302* 

0.740422* 

0.725868** 

0.075237  

0.216892*  

0.187* 

0.180728** 

0.190287** 

0.169752  

0.500000**  

0.5883 

0.28778 

0.493713 

0.106743  

0.500000**  

0.0897 

0.206662 

0.157376 
 

ADF and PP: Null hypothesis is that the variable being examined is  

non-stationary.  
KPSS: Null hypothesis is that the variable being examined is stationary.  

* and ** denotes statistical significance at 1% and 5% levels, respectively 

Source: Authors’ construct 

 

4.3. Regression Results  
The estimate for the parameter of the lag of the primary balance is 0.546. This is positive and larger than 0.50 

and positive. The meaning is that when past primary deficits increase by 1%,  primary balance would increase by 

0.55 in the current year. In general, these results point to a high degree of inertia present in government behaviour 

when it sets its primary balance. This finding supports that of Stoica and Leonte (2011) for the Greece economy. 

Also Burger et al. (2011) had similar results for South Africa. It can also be seen from the table that the primary 

balance is significant at the one percent level, while the debt is significant at the five percent level. It is revealed that 

when debt increases by 1%, primary balance would increase by 0.04. This finding agrees with Stoica and Leonte 

(2011) in their study for the Greece economy who found a similar result. It is also evident that the set of non-fiscal 

variables in the study have also had a relatively significant impact on economic growth. The results of the estimates 

are presented in Table 3. 

 
Table-3. OLS Regression Results 

Dependent Variable: Pb             Coefficient               t-statistic 

Constant  0.039913 (2.477970) 0.016107 

PB(-1) 0.546438* (0.152760) 3.577091 

DEBT -0.042474** (0.022170) -1.915813 

EXC -0.000208 (0.000185) -1.125290 

INFL 0.006589 (0.035051) 0.187994 
 

Adjusted R-squred = 0.54*, and * and ** denote 1% and 5% levels of significance respectively. Figure in ( ) indicates standard error.  

Source: Authors’ construct 

 



Economy, 2015, 2(1): 16-20 

 

 

 

 

20 

 

5. Conclusion 
Debt increases and debt accumulation has been a major economic issue the government of Ghana is dealing with. 

A bailout package has been sought to salvage Ghana’s economic challenges. The study sought to determine the role 

of budget deficits on the growth of debt. It will also evaluate the current fiscal stance on sustainable economic 

growth.  Annual time series data from 1980 to 2012 was used for the research. A fiscal reaction function based on the 

Intertemporal Budget Constraint was estimated using OLS technique. The Augmented Dickey-Fuller method was 

used to test for the stationarity of the variables. The results suggested a high degree of inertia present in government 

behaviour when it sets its primary balance. That is, past primary deficits have a positive and significant influence on 

current primary balance. Exsisting studies as indicated in the literature find support for the Greece Economy  in study 

by Stoica and Leonte (2011). Also Burger et al. (2011) researching for the South African Economy had similar 

results for South Africa. Further, the primary balance is significant at the one percent level, while the debt is 

significant at the five percent level. It is revealed that when debt increases by 1%, primary balance would increase by 

0.04. This finding is also supported by with Stoica and Leonte (2011) in their study for the Greece economy. The 

study therefore recommended the reduction in the size of Government and also to resort to alternative sources of 

financing expenditures rather than resorting to debt. 

 

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