The Effects of fiscal policy on public debt in Kenya: the moderating role of institutional quality

Abstract

The rising levels of public debt in Kenya have sparked concerns about the effectiveness of fiscal policies in ensuring sustainable debt management. This study examines the effect of fiscal policy on public debt in Kenya while considering the moderating role of institutional quality. Grounded on the Keynesian theory of public debt and the debt overhang theory, used a quantitative research approach, and collected secondary data from covering the period 1993–2023. The key fiscal policy indicators were revenue generation, government expenditure, and fiscal deficits. Institutional quality was the moderating variable, while foreign exchange rate was the control variable. Descriptive statistics was used to summarize the data using means and standard deviations. Diagnostic tests for normality, multicollinearity, autocorrelation, heteroskedasticity and cointegration were performed to test the assumptions for time series data. Autoregressive Distributed Lag (ARDL) time series model was used to examine the dynamic relationship between variables, including both past values of the dependent variable (autoregressive part) and past and current values of other variables (distributed lag part). Baseline ARDL model findings show that increased government revenue reduces debt growth, while high expenditure contributes to debt accumulation. Exchange rate depreciation and fiscal deficits show positive but mixed effects. Institutional quality alone had no significant direct impact, but its interaction with fiscal policies proved critical. Moderation ARDL model analysis revealed that better institutions reduce debt growth yet can also enable greater borrowing during high-revenue or deficit periods. In view of these results, the government should broaden the tax base, improve compliance, and diversify revenue. Prudent spending, reduced deficits, and strong institutions are key to sustainable debt.