Wagner's Law and the Dynamics of Government Spending in Indonesia

Abstract

The nature of the empirical relationship between public expenditure and economic growth can be analysed from different viewpoints. This study focuses on the empirical testing of the validity or otherwise of Wagner’s Law for the Indonesian economy. The high growth in the sample period 1980-2014 make Indonesia a likely candidate for it. Causality and cointegrating techniques are used. A key finding in our vector-autoregression analysis is unidirectional causality running from GDP and Prices to Government Expenditure supporting Wagner’s Law. In the case of Prices and Government Expenditure there is also evidence of a long-run cointegrating relationship, which appears stable and supports unidirectional causality. The vast majority of the deviations from the equilibrium relationship between Government Expenditure and Prices are found to be transitory shocks to Government Expenditure and significantly countercyclical with economic activity, suggesting that government expenditure does play a role in economic stabilisation.