National Income and Government Spending: Co-integration and Causality Results for the Dominican Republic

Abstract

This study investigates Wagner’s Law and the Keynesian hypothesis on the relationship between national income and government spending in the Dominican Republic during the periods of 1960-1984 and 1985-2005. Using the ‘bounds’ testing approach to the analysis of level relationships of Pesaran et al. (2001) and a method developed by Bårdsen (1989) to derive long-run coefficients, the results show the existence of a co-integrated relationship between gross domestic product and government consumption expenditure during the period 1960-1984. The estimate of the long run coefficient shows that a one percent increase in gross domestic product produced a 1.39 percent increase in government consumption spending. Moreover, Granger Pairwise causality tests show causal linkages running from gross domestic product to government consumption expenditure. The findings for the 1985-2005 period also confirm the presence of co-integration between gross domestic product and government consumption spending. However, the elasticity is below unity (+0.78). There is also evidence of causality from gross domestic product togovernment consumption spending. Combined, all these results show that Keynes’s hypothesis is found not to be valid for the case of the Dominican Republic.

Key words: Wagner’s Law, Keynesian hypothesis, national income, public spending, error correction model, ‘bounds’ test, Granger Pairwise causality