The Financial Scale Is The Stabilizer Of Economic Fluctuations

Since reform and opening up, the evolution of China Government size, measured with fiscal expenditure to GDP ratio shows a V-shaped curve, and the V-shaped point is located between 1994 and 1995. Fiscal scale was on a decrease till 1995, fiscal expenditures in GDP shrink in proportion, but since then on, the size of government emerged in the growing trend. By contrast, China's economic fluctuation marked obvious change during this period, after 1995, volatility of real GDP growth rate was relatively more stable compared with before. Is there a nexus between the two facts? Some literatures studied OECD countries and the United States show a negative correlation between Government size and economic fluctuations. Does this negative correlation exist in China? If the fiscal scale expansion in China can stabilize our economy? This is what this article tries to answer.After analyzing the situation of China government fiscal scale and economic fluctuations, we review the related literatures on government size and economic fluctuations and answer three questions: Why is the economic stability very important, which is the important logic premise behind our study; why should the Government provide economic stability and how is Government's ability to provide economic stability; the current literatures on the size of government and economic stability. Based on existed literatures, we use China's provincial-level panel data (1995-2006) to make an experience research on the relation between the local government fiscal scale and economy stabilization. According to our panel data model and econometric result, significant non-linear relationship exists between proportion of fiscal expenditure to GDP and economy fluctuation, no matter whether extra-budgetary factor is considered or not. With the increase of fiscal expenditure scale, economy fluctuation decreases, but after a certain scale, fiscal scale growth will lead to a rise in economic fluctuation. That is to say, there is a "U-Shaped" relationship between the two factors. This U-type relationship remains significant if we add more control variables.As for the channels through which government size reduces economy fluctuations, we come up with four types of hypothesis: automatic stabilizer channels, domestic demand insufficient and the context of the proactive fiscal policy, improved efficiency of government departments to use discretion fiscal policy, local government incentive brought by tax system reform and China's Fiscal Decentralization. Whether these channels are right should be test in our further research.