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Government Size And Macroeconomic Stability: Sub-national Evidence From China

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Executive Summary

Both theoretical predictions of Keynesian view and a large body of empirical studies on developed countries suggest that business cycle fluctuations can be partially smoothed by counter-cyclical fiscal policies. The paper extends this strand of literature by considering the nexus between output fluctuations and government size in the context of Chinese fiscal federalism. Using a sample of 29 Chinese provinces for the period of 1994-2007, the authors fail to provide consistent evidence for the stabilizing effect of fiscal policies. In particular, they find that under the tax assignment system, neither the central government's fiscal transfers nor the provincial budgetary and extra-budgetary revenues help reduce economic volatility. Such results are shown to be robust across different model specifications, volatility measures and estimation techniques.

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