Government Fiscal Policy on Economic Growth and Stability: An ECM Approach

This study rigorously examines the dynamic relationship between government fiscal policy instruments; government expenditure (GE), foreign direct investment (FDI), total revenue (TR), and budget deficit (BD) and economic growth and stability in Nepal, with Gross GDP as the dependent variable. Using an ECM and time series data from 2004 to 2023, the analysis reveals a robust long-run equilibrium, with an R-squared of 0.994, indicating that 99.4% of the variation in GDP is explained by these fiscal variables. Among them, TR and FDI exhibit statistically significant and positive effects on GDP, with TR having the largest long-run coefficient (3.538, p < 0.01), emphasizing the pivotal role of efficient and robust tax revenue mobilization in financing growth-enhancing sectors. FDI also contributes significantly (coefficient = 0.346, p < 0.01), highlighting its function in capital formation, technology transfer, and productivity gains. In contrast, BD shows a strong and statistically significant negative impact on GDP (coefficient = -3.253, p = 0.0024), signaling the detrimental consequences of prolonged fiscal imbalances. GE, while positively related to GDP, lacks statistical significance (p = 0.1507), suggesting inefficiencies in public expenditure that undermine its growth potential. Short-run ECM results affirm the relevance of FDI and TR (p = 0.0177 and p = 0.0056, respectively), while the error correction term (ECT = -1,313,716; p = 0.0503) confirms the presence of a stable adjustment mechanism toward long-run equilibrium. These findings underscore the urgent need for Nepal to realign its fiscal policy by enhancing revenue systems, promoting productive FDI, improving public spending efficiency, and reducing budget deficits. Future research should explore sector-specific impacts of these instruments, integrate political economy dimensions, and examine interactions with monetary policy to develop a more holistic fiscal framework for sustainable development.