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A re-examination of Granger causality between government expenditure and GDP

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Abstract

Based on data from different countries, a very strong correlation was noted between the growth rate of government expenditure and of nominal and real GDP. However, the direction of causality (which we specify as Granger causality) remains in dispute, especially regarding a stagnating economy such as Japan. This paper analyses the Granger causality between general government expenditure, nominal GDP and GDP deflators, using data from 38 OECD countries for the period 1980–2021. The preliminary results varied widely from country to country at different periods, but most results suggested the existence of Granger causality running from nominal GDP to government expenditure. In order to address the problem of spuriousness, which arises as a result of the statistics being recorded on an accrual basis, we tested for Granger causality by taking the lead variable (a variable at a later point in time) of government expenditure and found that the updated results often differed from the preliminary ones. To examine this finding in more detail, a Granger causality test was conducted using quarterly data from Japanese GDP statistics (1994–2021). One noteworthy outcome was that no Granger causality from nominal GDP to government expenditure was identified in Japan after 2008. When the lead variable of government expenditure was used as an explanatory variable, it became clear that the direction of Granger causality was unambiguously from government expenditure to nominal GDP, at least in the short term in Japan after 2008.

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Notes

  1. In what follows, we focus on relations between variables in the context of Granger causality tests (i.e. whether X Granger-causes Y), rather than causal relations in any ordinary sense of the term (i.e. whether X causes Y).

  2. Although there are a number of extant studies examining the relation between government expenditure and GDP, they cannot be included in the bibliography of this paper due to space limitations. The reader is referred to the bibliography included in the review article cited here [6].

  3. See [5], Chapter 7.

  4. The General Government Gross Expenditure (GGX) in the relevant IMF database is from the IMF's Government Finance Statistics (GFS). The GFS includes central governments as well as local governments and social security funds, etc., but does not include government enterprises ([4], p. 18). It also includes social security-related transfer payments, unlike government expenditure in the GDP statistics (IMF GFS database). The author's intention was to use government expenditure (government consumption and public fixed capital formation only), which is included in the definition formula for expenditure-side GDP, but statistics matching it were difficult to obtain in the database which includes many countries, so this was used instead.

  5. The calculations were performed using EViews (ver. 12), which was programmed to calculate all three variables for all countries at once. The number of lag variables to be included in the estimation Equation for each variable was automatically selected based on the Akaike Information Criterion (AIC).

  6. Unit root tests were only performed up to second-order differences, and those here that may require differences of a third or higher order are also denoted as I(2) for convenience.

  7. The calculations were made using EViews (ver. 12), which was programmed to perform Granger Causality tests for all three pairs of all target countries, including two periods of lag, automatically. Note that EViews has a simple Granger Causality view command. The author’s programme was designed to produce results that are identical to those produced by this command.

  8. It should be noted that the analysis in this section is based on a small number of data observations (about n < 40) which does not always allow for robust statistical analysis.

  9. The present discussion is primarily concerned with the Granger causality between the variables included in the Equation defining expenditure-side GDP, namely Y = C + I + G + NX, where G should be the government expenditure comprising GDP, and G includes GC and GI but not transfer payments (where aggregate demand is given through consumption). The IMF data in the section "Granger causality test with data from OECD countries" on general government gross expenditure, including transfer payments, was used as is because it was not possible to obtain standalone data on government consumption and government fixed capital formation from this database.

  10. Analysis before 2007 and after 2008 requires caution in interpreting the results, as the number of observations is small and the degrees of freedom are limited.

References

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Kwansei Gakuin University.

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  1. School of Policy Studies, Kwansei Gakuin University, Sanda-city, Japan

    Seung-Joon Park

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Correspondence to Seung-Joon Park.

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Park, SJ. A re-examination of Granger causality between government expenditure and GDP. IJEPS 17, 533–550 (2023). https://doi.org/10.1007/s42495-023-00114-y

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  • DOI: https://doi.org/10.1007/s42495-023-00114-y

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