Revisiting the Multiplier–Crowding-Out Trade-off: Empirical Evidence from Kenya

Abstract

This study investigates the complex interplay between government fiscal policy and economic growth in Kenya, focusing particularly on the balance between fiscal multipliers and the crowding-out of private investment. Using a quantitative approach, the research applies Local Projection Methods (LPM) to estimate the size and timing of fiscal multipliers and employs Vector Autoregressive (VAR) models to assess the extent to which public borrowing influences private sector investment. The analysis utilises time-series data spanning from 2000 to 2023, sourced from authoritative institutions such as the Kenya National Bureau of Statistics, the Central Bank of Kenya, the World Bank, and the International Monetary Fund. The results reveal that fiscal multipliers in Kenya are moderate in magnitude, with government spending raising GDP by approximately 0.25% in the short run, increasing to nearly 0.60% over a longer horizon. Notably, capital investments—especially in infrastructure and education—demonstrate significantly stronger multiplier effects compared to recurrent expenditure, which shows only limited influence on growth. The study also uncovers a pronounced crowding-out effect whereby heightened public borrowing leads to increased interest rates, thereby constraining private investment, particularly when public debt levels are high. Furthermore, the effectiveness of fiscal interventions is found to vary according to macroeconomic conditions, emphasising the importance of maintaining fiscal prudence. These findings highlight the critical need for strategic fiscal management, prioritising productive public investments alongside sustainable debt practices, to enhance economic growth and foster inclusive development in Kenya