A Study On The Nonlinear Correlation Mechanism Between Fiscal Policy And Business Cycle Fluctuation

Research on the nonlinear correlation mechanism between fiscal policy andbusiness cycle fluctuations has always been a hot topic for academia and policymakers.The Keynesian school of economics states: due to the widespread imbalances inmarket trading costs and information, the market mechanism is limited in itseffectiveness, especially when the economy enters a recession or depression andpolicymakers need to reevaluate the situation. The Ricardo school of economicsstates: from a completely rational perspective, debt taken on by governments in thepresent will lead to greater taxes in the future, and as such, fiscal policy is unable tochange equilibrium output, and is limited in its ability to iron out business cyclefluctuations. Even though different schools of economics have differing views on theeffects of fiscal policy, all nations still undertake proactive fiscal policy in the face ofeconomic slowdown. This begs the question, does the effectiveness of fiscal policyin ironing out fluctuations differ at different stages in the business cycle? This paperanalyzes this question, researching the nonlinear characteristics of the mechanismbetween fiscal policy and economic growth, and providing empirical evidence on theeffects of China’s new round of fiscal policy.In this paper, there are three main conclusions. First, the statistical results forthe coefficients for economic variables show there is only a weak same periodcorrelation between fiscal spending and economic output; this shows that in the shortterm fiscal spending is limited in its ability to prop up economic growth. However,fiscal spending has a strong correlation with economic growth three and fourquarters later, showing that fiscal policy has strong discretionary characteristics, butthere exists a certain time lag. Second, when comparing the “soft landing” of1996to the present day, there is an obvious difference in fiscal policy. During the “softlanding” period, fiscal revenue growth increased by up to20.8%, whereas in the current period, growth has only increased by15.9%; this shows that the currenteconomic downturn is more serious, and that it is more difficult to increase fiscalrevenue. In comparison, under current monetary policy limitations, in order tocontrol the downward economic slide, average increases in fiscal spending havereached19.4%, which is higher than the18.1%seen during the “soft landing” period;this only highlights the effects of fiscal policy in the current business cycle. Third,the regression results from the Markov Regime Switching Model show that Chinesefiscal policy mechanisms exhibit obvious stage characteristics. The currentmacroeconomic operations and fiscal policy regulations are largely similar to the“soft landing” period from1996-2002; the Chinese government is increasing fiscalpolicy localization, while also focusing on the actual execution of fiscal spendingpolicies. Also, since China is currently in a transition period for with regards tomacroeconomic growth, fiscal spending growth will naturally begin to slow; as timegoes on China’s fiscal spending growth will slow and begin to stabilize. As such,in the current period, relevant government ministries must focus on the effect offiscal policy adjustments on the economy as a whole, realizing the economicstabilization that fiscal policy can provide; this includes focusing on adjustingincome distribution, facilitating stable domestic economic growth and relevant riskprevention. This will allow China’s fiscal spending to reach new levels of efficacyand efficiency.Lastly, this paper shows that the correlation between fiscal policy and economicgrowth shows obvious asymmetries; notably, in times of high economic volatility,fiscal spending should be more geared towards ironing out business cyclefluctuations, and despite lower short term effectiveness in times of low economicvolatility, fiscal policy is still has a stabilizing effect on the economy and can ironout outside output shocks. It also needs to be pointed out, since during lowfrequency fluctuation regimes fiscal policy has only a limited effect on economicgrowth, this new period of macroeconomic controls requires the government andministries to emphasize fiscal policy execution to ensure effectiveness, providing macroeconomic underpinning during the continued economic slowdown. Also, wealso showed latent risks exist in the current macroeconomic environment; while anoverabundance of available currency greatly limits the effect of monetary policy,monetary policy is the safeguard of proactive fiscal policy. This means that in thelong term, fiscal spending growth will necessarily begin to slow, and the governmentand Ministry of Finance must increase scrutiny of fiscal policy efficiency, to effectstabilization of the economy, and provide a macroeconomic underpinning in this newperiod, allowing more time for reform and economic restructuring.