The Effect of Fiscal Policy in Indonesia: Structural VAR Analysis

This paper is an attempt to investigate the effect of fiscal policy on output in Indonesia using Structural Vector Autoregression (SVAR) methodology for the period 1983:1 – 2010:1. We use contemporaneous restriction and follow Blanchard and Perotti (1999) technique to identify structural fiscal policy shocks in Indonesia. The estimation results show that the government spending shocks are found to have relatively small (though positive) but insignificant effect on output. Moreover, the spending composition matters as government investment gives better impact on output than government consumption. In this study, we investigate also the effect of fiscal policy on GDP component in term of private component and private investment. The results also show similar story with the aggregate level in which give positive sign but insignificant on both components. Overall, the findings indicate the less potent fiscal policy to stimulate output while putting upward pressure on nominal interest rate.