The Impact of Fiscal Policy on the Real Exchange Rate: Anecdotal Evidence from Tanzania

In macroeconomics theory of open economies, it is argued that an adverse fiscal imbalance results into a higher real interest rate. In turn the higher real interest rate reduces net foreign investment and that this leads to an appreciation of the domestic currency. This study is a preliminary empirical investigation of the extent to which the budget deficit in Tanzania has had any relationship with the real interest rate and the real exchange rate. After analysing relevant data covering almost three decades beginning in 1968, the study finds no evidence to support the above theory. Further empirical work remains to be done in order to establish the link between a budget deficit and movements in the real exchange rate for a small but open economy such as Tanzania. Only in this way can one justify the prevailing concerns among policy makers in Tanzania over the need to eliminate the budget deficit due to its alleged adverse effect on other macro-economic indicators. African Journal of Finance and Management Vol.8(1) 1999: 28-3