Assessment of Long and Short Run Relationship Amongst Macroeconomic Variables and Economic Growth of Nepal

Abstract

 This paper examines the long and short run relationship among selected macroeconomic variables and economic growth of Nepal. The objective of the research is to examine empirically the long and short run relationship among macroeconomic variables; gross fixed capital formation, human capital, government expenditure, foreign aid, and trade openness on economic growth of Nepal. The study period spanned from 1975 to 2016. The data has the annual frequency. The time series properties of the data were, first, analyzed using the Augmented Dickey-Fuller (ADF) test and then Auto-Regressive Distributive Lag (ARDL) approach to cointegration is employed to assess the direction of impact and long-run relationships between the variables. Besides these, other diagnostic tests are also conducted. The ARDL bound test analysis depicts the presence of cointegration relationship between real GDP and employed macroeconomic determinants. The negative and significant error correction coefficient further provides substantial evidence that there is long-run association among real gross domestic product and selected macroeconomic variables. The ARDL model shows that Gross fixed capital formation and government expenditure have a significant positive relationship on economic growth in the long run while trade openness has a significant negative relationship on economic growth in the long run. Thus, the findings suggest that GFCF and GE are the major macro determinants to robust the economic growth of Nepal. In order to achieve the desired rate of economic growth it is suggested that there should be a continuous investment in gross fixed capital formation including plants, machinery, raw materials, industrial buildings and technology (research and development). It is also suggested that structural changes should be made in school institutions with the provision of providing quality education with cognitive skills and added resources through quality and skilled teachers. Nepal must have more effective trade openness, particularly by productively controlling import of consumption goods, and by introducing import substitution policies, in boosting their economic growth through international trade.