The Effect of Monetary Policy Variables on Tax Revenue Collections in Uganda

Abstract : This study investigates the extent to which monetary policy instruments influence tax revenue mobilization in Uganda, with particular emphasis on the exchange rate, broad money supply (M2), and interest rates. Using annual time-series data and a Vector Error Correction Model (VECM), the study examines both the short-run dynamics and long-run equilibrium relationships between monetary policy variables and tax revenue performance. The results indicate the existence of a stable long-run relationship among the variables. Empirically, expansions in M2 are found to exert a positive and statistically significant effect on tax revenue, suggesting that increased liquidity stimulates taxable economic activity. Exchange rate depreciation also significantly enhances tax collections, reflecting its impact on trade-related and nominal revenue bases. In contrast, interest rates exhibit a negative but statistically insignificant effect on tax revenue, implying a limited direct transmission channel through revenue mobilization. The study contributes to the empirical literature by providing evidence on the monetary–fiscal transmission mechanism in a low-income, structurally transforming economy, highlighting how monetary policy indirectly supports domestic revenue generation. From a policy perspective, the findings underscore the importance of maintaining adequate liquidity growth while safeguarding macroeconomic stability. A cautiously managed exchange rate regime is recommended to harness revenue gains from moderate depreciation without amplifying volatility. Although interest rates appear weakly linked to tax revenue, prudent adjustments remain essential to avoid crowding out private sector activity. The study further emphasizes the need for stronger coordination between the Bank of Uganda, the Ministry of Finance, and the Uganda Revenue Authority, alongside structural reforms aimed at financial deepening, formalization, and improved tax compliance.