Asian Journal of Research in Business Economics and Management
Year : 2018, Volume : 8, Issue : 4
First page : ( 28) Last page : ( 41)
Online ISSN : 2249-7307.
Article DOI : 10.5958/2249-7307.2018.00034.8

A Review of Revenue-Expenditure Nexus in India: The Empirical Evidence of Lucas Critique

Saha Subrata*

*Associate Professor, Department of Economics, Raiganj University, Uttar Dinajpur. West Bengal. India. subratasahaeco19@gmail.com

Online published on 11 April, 2018.

Abstract

According to Lucas critique, it is inappropriate to estimate econometric models of the economy, in which endogenous variables appear as unrestricted functions of predetermined variables. In the classical time series regression model parameters are assumed to be constant implying that the econometric relationship will remain stable over a long period of time under different scenarios. Lucas argues that dynamic economic theories hold that this assumption is not true. Consequently we should expect that the econometric relationships might change as the scenarios change over the time period. The relationships among the variables undergo changes following structural changes in the economy. This paper uses Recursive Residual Test and CUSUM Square test to identify possible structural changes in the existing relationship between government revenue and its expenditure in India during 1975–2013 and to investigate the causal relationship between government revenue and its expenditure under different sub-periods. Our empirical results suggest that the causal relationship between government revenue and its expenditure in India has undergone a significant change before and after structural change. An econometric study exhibits a Uni-directional causal relationship running from expenditure to revenue during the first sub-period 1975–1992 and during second sub-period 1993–2013 the study reveals that revenue does cause (Granger) expenditure i.e Tax-and-spend Principle in India. Therefore the study establishes the relevance of ‘Lucas Critique’ in case of fiscal management in India.

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Keywords

Government Revenue, Government Expenditure, Unit Root Test, Cointegration, VECM, Chow Test & Recursive Residual Test.

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