The Causal Relationship between Government Revenue and Expenditure in China: An Application of Vec and VAR Modelling

Abstract

Unsatisfied with little evidence provided on various hypotheses concerning the revenue-expenditure relation in China, this paper is an empirical endeavour to fill the gap through a battery of econometric tests for causality based on VEC and VAR models. A more comprehensive testing strategy for unit roots and cointegration has been suggested, and a bi-directional causality pattern has been found in China's government finance. The paper thus concludes that attempts simply to change revenue or expenditure or both without taking into account of the interdependence between the two may be counter-productive, and the effects on aggregate demand of government debt-financing in the presence of inflation may not be as detrimental as some economists would expect.

Keywords: Government revenue, Government expenditure, Granger causality, Stationarity, Cointegration

JEL Classification: H60, C12