New Evidence of Causal Relationships Between Government Spending and Economic Growth in the United Kingdom

Abstract

Driven by the unfolding asymmetry in the United Kingdom output dynamics since 1955, this paper aims to explore the contribution of fiscal policy. To this end, the dynamic connectivity between United Kingdom government spending and economic growth is assessed through the concept of causality. Since the implementation of economic policy can asymmetrically affect output dynamics, both linear and nonlinear causality tests are employed. The empirical findings underscore the feature of nonlinearity. The detected nonlinear causality appears to be subject to different economic regimes. During the Great Moderation, the linear connectivity between government spending and economic growth strengthened, while in the post-2007 era, the absence of substantial linkages supports the idea that the information transmission channel between government spending and economic growth is broken. The study’s novelty lies in the implementation of linear and nonlinear causality tests within a rolling windows analysis framework. This approach enables the exploration of connectivity characteristics between United Kingdom government spending and output growth under changing monetary policy and economic stances. The findings confirm the role of fiscal policy as an economic stabilizer, mainly during periods of loose monetary policy with moderate inflation and predominantly positive economic growth rates. The results also reveal a significant structural break in 2007, coinciding with a change in monetary conditions and a period of limited fiscal control over output growth.