Is public expenditure driven by economic growth or vice versa? Wagner's Law vs. Keynesian Hypothesis

What is it about?

This study analyzes the dynamics between public expenditure and economic growth in Peru for 1980Q1–2021Q4. We used quarterly time series of real GDP, public consumption expenditure, public expenditure, and the share of public expenditure to output. The study of stationary time series assesses whether Wagner’s law, the Keynesian hypothesis, the feedback hypothesis, or the neutrality hypothesis is valid for the Peruvian case according to Granger causality. We found cointegration between real GDP and public expenditure, and public consumption expenditure and real GDP. Estimating error correction and autoregressive distributed lag models, we concluded that Wagner’s law and the Keynesian hypothesis are valid in the Peruvian case, expressed as dynamic processes that allow us to obtain short-run and long-run impacts, permitting the mutual sustainability of economic growth and public expenditure.

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Photo by Chris Liverani on Unsplash

Photo by Chris Liverani on Unsplash

Why is it important?

We conclude that Wagner’s law and the Keynesian hypothesis are validated in Peru expressed as dynamic phenomena that allow us to obtain short-run and long-run impacts, permitting the mutual sustainability of economic growth and public expenditure. The positive dynamic impacts relative to Wagner’s law fall within their theoretical ranges, showing the type of fiscal policy adopted, reflected through the income elasticity of public expenditure. The Keynesian hypothesis shows positive impacts only for long-run equilibrium relationships reflected through the income inelasticity of public expenditure, and negative impacts in a dynamic model reflected through a stationary share of public expenditure. Thus, public expenditure increases at a higher rate driven by economic growth, and economic growth increases at a lower rate driven by public expenditure.

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