Effect of Deficit Financing on Economic Growth in Bangladesh: Cointegration and VECM Approach

Abstract

Bangladesh has been encountering a budget deficit since 1972 because of a decrease in the source of income. This paper aims to examine the effect of budget deficit financing on economic growth in Bangladesh throughout 1981–2018. Using secondary data, the paper uses the cointegration test, vector error correction mechanism (VECM) and Granger causality test. Johansen’s cointegration test outcomes find that the study variables are cointegrated and subsequently have a long-run nexus among the variables. The study finds that in the long run, government domestic debt (GDD), government external debt (GEXD) and money supply (MS) affect positively economic growth (RGDP). The outcomes of the VECM approach express that in the short run, GDD, external debt and MS negatively affect economic growth. Also, short-run causality runs from the GDD, GEXD and MS to economic growth. The Granger causality test result shows unidirectional causal nexus running from GDD to RGDP, RGDP to external debt and GEXD to MS, and bidirectional causal nexus between MS and GDD in Bangladesh. The study suggests the governments should enhance moderate levels of domestic and external borrowing and uses it in productive and efficient ways to accelerate economic growth in Bangladesh.