Impact_of_Fiscal_Policy_on_Economic_Growth_in_Iran

European Journal of Economics, Finance and Administrative Sciences ISSN 1450-2275 Issue 36 (2011) © EuroJournals, Inc. 2011 http://www.eurojournals.com Impact of Fiscal Policy on Economic Growth in Iran Mehdi Safdari Assistant Professor of Faculty of Economics University of Sistan and Baluchestan, Iran Masoud Abouie¬¬ Mehrizi Islamic Azad University, Mehriz Branch, Iran Marzie Elahi Islamic Azad University, Mehriz Branch, Iran Abstract In this paper, equivalence relation and long term of six variables Gross domestic product growth rate, Gross domestic product growth rate, Growth of exchange rate, Growth of the price index of goods and services, Growth of government consumption expenditure, Growth of government investment spending and Growth of incomes tax and also their influences on each other in Iran and for years 1973-2008 has been analyzed. In this purpose vector autoregressive model (VAR) has been used. First, stability of variables by the use of dickey-fuller test has been examined. Next, analysis of Johnson test for considering the convergence among six variables has been used. The results of this research show that variables of Gross domestic product growth rate, Gross domestic product growth rate, Growth of exchange rate, Growth of the price index of goods and services, Growth of government consumption expenditure have negative effect on economic growth and variables of growth of incomes tax and Growth of government investment spending has a positive effect on economic growth. Keywords: Fiscal Policy – Gross domestic product growth rate–Vector Autoregressive Model (VAR). JEL Classification Codes: C22, O47 1. Introduction Macroeconomic relationship between fiscal policy and economic growth always has been of interest to economists. For this reason many studies have been done in this area. A group of economists believe that economic growth is the result of capital accumulation and other group believes that technical progress is effective and do not accept that economic growth Is influenced by factors such as fiscal policy. To examine the effects of fiscal policy on economic growth, first need to be properly classified and then Impact of each of them separately to be examined on economic growth. These tools are mainly made up of three groups: taxes, government expenditure and policy of Overall budget balance and each of them is able to affect on economic growth in many ways. In this paper we investigate effect of each of these tools on economic growth. Fiscal policy has been used in many articles. 88 European Journal of Economics, Finance And Administrative Sciences - Issue 36 (2011) Arin and Spagnolo (2010) in their article titled ‘Short-term growth effects of fiscal policy revisited: A Markov-switching approach’ investigated the growth effects of three different types of tax policy innovations on short-term economic growth within a Markov-switching framework applied to the U.S. economy. This paper used a Markov switching framework to measure the impact of fiscal policy on output growth dynamics for the U.S. economy. Taxes on household and corporate income were much more harmful than taxes on consumption. Tax cuts focusing on income and corporate taxes are more effective in stimulating the economy. Tosum (2008) in his article titled ‘Endogenous fiscal policy and capital market transmissions in the presence of demographic shocks’ addressed aging in an open economy framework with two regions that have politically responsive fiscal policy regarding education finance. Demographic shocks start an economic growth process but results are sensitive to a critical parameter in the model that indicated return to education spending. Low values of this parameter are associated with less favorable economic outcomes. Hence, a policy implication emerged that enhancing the education system might pay off in terms of easing the negative growth and welfare consequences of expected demographic shocks. Gupta and Barman (2009) in their article titled ‘Fiscal policies, environmental pollution and economic growth’ developed a model of endogenous economic growth with special consideration to the role of productive public expenditure and environmental pollution; and analyzed the properties of optimal fiscal policy in the steady state growth equilibrium. They considered the level of consumption as the source of pollution. Government allocates its tax revenue between pollution abatement expenditure and productive public expenditure. Optimum ratio of productive public expenditure to national income was equal to the competitive output share of the public input, when productive public expenditure is depicted as tax revenue minus abatement expenditure. However, the proportional income tax rate exceeds the competitive output share of the public input. There was no conflict between the social welfare maximizing solution and the growth rate maximizing solution in the steady state growth equilibrium. Carmignani (2007) in his article with titles ‘The impact of fiscal policy on private consumption and social outcomes in Europe and the CIS’ studied the effects of fiscal policy on per-capita private consumption and social outcomes in a simultaneous equations framework. The focus was on transition economies and the model specification allows for a non-linear response of socio-economic variables to fiscal policy depending on the fiscal regime. Key results this article are (i) fiscal policy has Keynesian effects in transition countries and non-Keynesian effects in high-income OECD economies, but only outside normal times, (ii) public health and social protection expenditure improve social outcomes, and (iii) there is evidence of electoral business cycle of fiscal policy in both transition and high-income countries. Traum and Yang (2010) in their article titled ‘Monetary and fiscal policy interactions in the post-war U.S.’ used A New Keynesian model for an active monetary and passive fiscal policy (AMPF) regime and a passive monetary and active fiscal policy (PMAF) regime is estimated to fit various U.S. samples from 1955 to 2007. Their results showed that data in the pre-Volcker periods strongly prefer an AMPF regime, even with a prior centered in the PMAF region. The estimation, however, is not very informative about whether the Federal Reserve's reaction to inflation is greater than one in the preVolcker period, because much lower values can still preserve determinacy under passive fiscal policy. In addition, whether a PMAF regime can generate consumption growth following a government spending increase depends on the degree of price stickiness. An income tax cut can yield an unusual negative labor response if monetary policy aggressively stabilizes output growth. Dioikitopoulos and Kalyviti (2008) in their article titled ‘Public capital maintenance and congestion: Long-run growth and fiscal policies’ studied an endogenous growth model, in which public maintenance expenditures affect the depreciation rate of public capital and the latter is subject to congestion. They found that economies with low congestion in public infrastructure will require a threshold level of public capital maintenance for ongoing growth. They also examined the fiscal implications of public capital maintenance policies and they found that the composition of public capital expenditures under congestion is a crucial determinant of optimal and growth-maximizing fiscal 89 European Journal of Economics, Finance And Administrative Sciences - Issue 36 (2011) policies. The government can affect the return of public capital by re-allocating public expenditures between ‘new’ public investment and maintenance and hence avoid excessive taxation that is required under increasing congestion. Staehr (2008) in his article titled ‘Fiscal policies and business cycles in an enlarged euro area’ compared the cyclical properties of fiscal policies across the 12 original euro zone countries and the future members from Central and Eastern Europe. For the sample period 1995–2005, the fiscal balance exhibited less inertia and is more counter-cyclical in Central and Eastern European countries than in members of the euro zone. The main differenced arise from the revenue side. Differences in the formation of fiscal policy between current and future euro zone countries decreased over time. Both autonomous and counter-cyclical fiscal policies have little or no effect on cyclical variability in the euro zone countries, while such policies appear to be effective in Central and Eastern European countries. The rest of the paper is organized into four main sections: Section 1 analyses previous studies. Section 2 describes the data and the econometric methodology. Section 3 discusses the results that emerge from the estimations. The conclusions of this paper are then presented in section 4. 2. Data and Methodology We use this data from 1973 to 2008 of Iran. We found them in Central Bank of Iran. One vector autoregressive (VAR) model which possess k as exogenous variable. And p as time`s inhibition for each variable, in shape matrix is shown as following: Yt = A t Yt −1 + A 2 Yt −2 + … + A p Yt −p + U t ≈ IN(0, ∑ ) In this relation, and it`s lags, k×1 vectors are related to models variables. , i= 1, 2,…, p are model`s coefficients for k×k matrix. And , k×1 vector is related to terms of model`s error. Now for linking short term behavior of to long term balance values, we can bring above relation as vector error correction model as following: ∆Yt = β t ∆Yt −1 + β 2 ∆Yt − 2 + … + β p −1∆Yt − p −1 + ∏ Yt − p + U t Where: Bi = −(I − A1 − A 2 − ... − A P ) i = 1, 2, … , p − 1 Π = −(I − A1 − A 2 − … − A p ) Matrix π contains of information of long term balance variables. We follow the Johansen approach in determining long-run relationships. Patterson (2000) and Doornik and Hendry (2001) provide a full treatment of the issues involved in this method. The first step is to estimate the VAR in levels with an appropriate lag structure. The next stage involves determining the cointegrating rank, i.e. the number of long-run equilibrium relationships or cointegration vectors among the variables. Finally, toallowareasonable interpretation of the results, cointegration vectors are identified (Abouie, 2011). 2.1. Theoretical Principles The model which is used for investigating impact of fiscal policy on economic growth in Iran is defined as following: GDPR = α 0 + α 1CPIR + α 2 ERR + α 3 GCR + α 4GIR + α 5 TTR + U t Where: GDPR: Gross domestic product growth rate CPIR: Growth of exchange rate ERR: Growth of the price index of goods and services GCR: Growth of government consumption expenditure GIR: Growth of government investment spending TTR: Growth of incomes tax 90 European Journal of Economics, Finance And Administrative Sciences - Issue 36 (2011) 3. Findings/Discussion We use the above formulation to estimate a VAR model containing sex variables. Table 1: Variable Definitions and Descriptions Variable GDPR CPIR ERR GCR GIR TTR DESCRIPTION IPTION Gross domestic product growth rate Growth of exchange rate Growth of the price index of goods and services Growth of government consumption expenditure Growth of government investment spending Growth of incomes tax As the time of accumulation analysis, statistical properties of variables are very important. In fact, the accumulation method tests with theory the compatibility among statistical properties of the model’s variables. Economic variables are generally non stationary and they are a random process. Linear combination of non stationary series in general is a non stationary series and closely associated with economic theory. Because economic theory guarantee stagnation of combination of economic variables so in this study Dickey Fuller’s generalized Test for investigation of variables stationary is used. The results of the test for the variables in levels are presented in Table2. The results reported in Table 2 showed that all variables are I (0). Table 2: ADF tests for unit roots Variable ADF GDPR CPIR ERR GCR GIR TTR -3.79 -3.99 -3.41 -4.42 -7.76 -4.66 1% -3.57 -3.57 -3.57 -4.16 -3.57 -3.62 Critical Value 5% -2.93 -2.93 -2.93 -3.51 -2.93 -2.94 Lag 10% -2.61 -2.61 -2.60 -3.18 -2.61 -2.61 0 0 0 0 0 0 After investigation of persistent of variables, one of the important stages in evaluation of vector regression model is choosing rank of pattern. For choosing optimum rank of pattern, we can use criterion of Akaike or Schwarz. The most lag which is given to model is 2, and considering table (3), the least quantity of Akaike and Schwartz statistics are prepared in first lag, we can indicate that the optimum lag of VAR model is equal to 1. Table 3: Determination of magnitude of lag of VAR model Schwarz information -7.41 -9.11 -5.51 Akaike information -9.27 -9.37 -8.98 Lag 0 1 2 In this article we follows vectors and accumulated vector among variables of Gross domestic product growth rate, Gross domestic product growth rate, Growth of exchange rate, Growth of the price index of goods and services, Growth of government consumption expenditure, Growth of government investment spending and Growth of incomes tax by the use of Johansson’s method. In Johnson’s method after doing necessary calculations for studding existence of convergence we use two criterions consist of and . 91 European Journal of Economics, Finance And Administrative Sciences - Issue 36 (2011) If existence of convergence among variable is verified, we can say that balance and long term relation among variable is established. Results which are concluded from effect's examination and examination of maximum specific values for determination of accumulated vectors among model's variables are presented in tables 4, 5. Table 4: Test Statistics for Co integrating rank (Max tests) Null r=0 r≤1 r≤2 r≤3 Table 5: alt r≥1 r≥2 r≥3 r≥4 Critical value 40.08 39.25 27.58 21.13 42.04 33.88 21.49 17.20 Probe 0.0296 00104 0.2473 0.1628 Test Statistics for Co integrating rank (Trace tests) Null alt Critical value r=0 r≤1 r≤2 r≤3 r≥1 r≥2 r≥3 r≥4 95.75 69.82 47.86 29.80 Probe 140.98 98.94 59.69 38.19 0.0000 0.0001 0.0027 0.0043 The magnitudes of vectors which are prepared by statistic of examination effect matrix are equal to 4 vector and magnitudes of vectors which are prepared statistic of maximum specific values are equal to 1. Considering that examination of maximum specific values is stronger than examination of effect matrix. Therefore for determination of magnitude of accumulated vector, examination of maximum specific values is used. Considering results of above tables in level of probability of 95 percent magnitude of long term relations among variables compatible pattern with economic theory is equal to (r=1)1 is determined. Table 6: Co integrating vectors Variables GDPR(-1) CPIR(-1) ERR(-1) GCR(-1) GIR(-1) TTR(-1) C Vector 1 1.00 0.29 (2.86) 0.13(2.12) 0.13(1.56) -0.31(-5.44) -0.15(-2.89) -0.06 In table6, Numbers in parentheses are statistic of accounting t. Considering prepared results within investigated period, variables of Gross domestic product growth rate, Gross domestic product growth rate, Growth of exchange rate, Growth of the price index of goods and services, Growth of government consumption expenditure had negative effect on economic growth and variables of Growth of incomes tax and Growth of government investment spending has positive effect on economic growth. 4. Conclusion Generally, in this article linkage between fiscal policies in Iran investigated. In this article, first we presented a model and estimated this model, in order to fitness of VAR pattern we used unit root test, then the magnitude of inhibition of VAR model was determined after that by using of Johansson’s and 92 European Journal of Economics, Finance And Administrative Sciences - Issue 36 (2011) existence of accumulated vectors showed long term relations among variables. After certainty about existence of long term relation, we estimated this relation and then interpreted these coefficients. The results of this research show that variables of Gross domestic product growth rate, Gross domestic product growth rate, Growth of exchange rate, Growth of the price index of goods and services, Growth of government consumption expenditure had negative effect on economic growth and variables of Growth of incomes tax and Growth of government investment spending has positive effect on economic growth. Taxes have been identified an important tool in economic policy and from major variables that Government using its affect on macro-economic variables such as economic growth, inflation and unemployment and important share of taxes from GDP can be evidence of effectiveness tax policy in economy. Growth of exchange rate causes foreign raw material is more expensive and lead to higher production costs thus growth of exchange rates affects negatively on economic growth. Increase in government investment expenditure causes economic growth because increase investment in infrastructure leaded to Greater private sector activity and causes increase in gross domestic product. References 1] 2] 3] 4] 5] 6] 7] 8] 9] Abouie M, Safdari M (2011). External debt and economic growth in Iran, Journal of Economics and International Finance, Vol. 3(5), pp. 322-327 Arin K, Spagnolo N (2010). Short-term growth effects of fiscal policy revisited: A Markovswitching approach Economics Letters, Volume 110, Issue 3, pp. 278-281. Carmignani F (2007). The impact of fiscal policy on private consumption and social outcomes in Europe and the CIS, Journal of Macroeconomics, Volume 30, Issue 1, pp. 575-598. Dickey D, Fuller W.A. (1979). Distribution of the Estimators For Time Series Regression With Unit Root, Journal Of American Statistical Association, 74. Dioikitopoulos E, Kalyviti S (2008). Public capital maintenance and congestion: Long-run growth and fiscal policies, Journal of Economic Dynamics and Control Volume 32, Issue 12, pp. 3760-3779. Gupta M, Barman T (2009). Fiscal policies, environmental pollution and economic growth Economic Modelling, Volume 26, Issue 5, pp. 1018-1028 Staehr K (2008). Fiscal policies and business cycles in an enlarged euro area, Economic Systems, Volume 32, Issue 1, pp. 46-69. Tosum M (2008). Endogenous fiscal policy and capital market transmissions in the presence of demographic shocks, Journal of Economic Dynamics and Control, Volume 32, Issue 6, pp. 2031-2060. Traum N, Yang S (2010). Monetary and fiscal policy interactions in the post-war U.S., European Economic Review, Volume 55, Issue 1, pp. 140-164. Copyright of European Journal of Economics, Finance & Administrative Sciences is the property of EuroJournals, Inc. and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.