Nonlinear Effects of Fiscal Policy on Private Consumption: Evidence from China

Abstract In the present paper, we use the Markov‐switching model to test the nonlinear effects of government expenditure and taxes on private consumption in China. The results show that fiscal policy in China has a significantly nonlinear effect. In years 1978–1980 and 1984–1997, the effect of government consumption on private consumption is non‐Keynesian. During the same periods, the effect of taxes is also non‐Keynesian, but the effect is not significant. The effect of government investment is linear but asymmetric. After retesting the reasons for the existence of nonlinear effects, we find that in China initial fiscal conditions and the magnitude of fiscal consolidations are not related to the nonlinear effects of fiscal policy. The government should pay close attention to the characteristics of commodity and labor markets to identify the conditions and regimes associated with nonlinear effects.