The Revenue-Expenditure Nexus: A Note of Two Cypriot Economies

The paper investigates the long-run and the causal relationship among public revenue, public expenditure and GDP for two Cypriot economies (North and South) for the period 1977-2006, using the autoregressive distributive lag approach to cointegration and a modified version of the Granger causality test. For South Cyprus, the paper finds a long-run relationship as well as a unidirectional Granger causality running from government revenue to government expenditure, implying that boosting government revenue can eliminate their budget deficits. In contrast, for the North Cyprus, the paper finds neither a long-run nor a causal relationship, implying that expenditure decisions are made in isolation from revenue decisions. The absence of cointegration in the North points to an unstable long-run comovement of the two fiscal variables indicating unsustainability of fiscal policy. As there is no causality in any direction between the two fiscal variables, North Cyprus can manipulate revenue or expenditure or both in order to reduce its budget deficits, but this may lead to further worsening of the deficit if expenditure grows relatively faster than the revenue.