The Inflation-Government Revenue Nexus in a Small Open Economy: Evidence from the Gambia

Abstract

This paper is a thorough examination of the relationship between inflation and government revenue stability in The Gambia for the period 2006 to 2024 using annual time series data. A comprehensive econometric approach was undertaken, beginning with stationarity diagnostics using both the Augmented Dicky-Fuller (ADF) and KPSS test to assess the integration properties of the series, followed by Ordinary Least Squares (OLS) regression with heteroskedasticity-consistent (HC3) to ensure robust inference. The analysis revealed a significant positive relationship between inflation and real government revenue growth. Different from the traditional Tanzi effect hypothesis, a 1% rise in inflation will entail a 3.558% rise in real revenue growth with a p-value of 0.032. Conversely, high inflation shocks (exceeding 12%) lead to a drop in revenue growth of 36.227 percentage points. All diagnostic tests substantiate model validity with no autocorrelation (Breusch-Godfrey p = 0.672), no heteroskedasticity (Breusch-Pagan p = 0.302), and acceptable normality (Jarque-Bera p = 0.111). These findings not only refute the traditional fiscal theory but also imply significant policy reforms in inflation targeting and revenue prediction for small open economies with non-indexed tax systems.