Cross-causality of Nominal Gross Domestic Product's components:

Empirical study on Austria’s quarterly panel data analysis

Trung Tran Minh Vu

International School Ho Chi Minh City
Ho Chi Minh City, Vietnam
vinceny.fe@gmail.com

Abstract:
We test for Granger causality between the components of the real Gross Domestic Product under
the expenditure calculation. Our work has important implications on the possible impact
policymakers need to consider on the different real GDP components when one component face
changes. Using the Toda-Yamamoto procedure, we found bidirectional Granger causality running
between government expenditure with export, business investment with export, and domestic
consumption with import; along bidirectional causality, we also found three unidirectional
causality between the components.

Keywords: Panel Granger cross-causality, GDP components, Toda-Yamamoto’s procedure

Introduction:
The Gross Domestic Products (GDP) has been crucial to measure economic growth within a
country. In this paper, we address the calculation of expenditure GDP. This particular measure
aggregates four components: personal domestic consumption, business investments, government
spending, and net export. We addressed the cross-causalities between the four aforementioned
components with over 20 years of data of Austria’s national account. Our findings have important
implications for Austrian policymakers, namely in the consideration of interdependence between
endogenous variables. With the calculations, policymakers may be able to gauge the
macroeconomic effects of certain changes and plan fiscal or monetary policies from there.

Literature Review:
Many papers have addressed the correlation, cointegration, or in general the relationship between
GDP and other indicators. Some took a step further and addressed the causality or impact of certain
macroeconomic or development indicators on GDP. Neofytidou and Fountas (2019) explored the
impact of health on GDP. They found that all life expectancy indicators have a positive and
significant short-run as well as long-run effect on per capita and total income and concluded that
health is a significant element that affects an economy’s performance.

There are also works done upon the interrelationship between economic growth, as indicated by
GDP, and its components. Anghelache et al. (2017) explored the correlation between final
consumption components and expenditure GDP and suggested an arbitrary fact that the former has
a strong influence on the latter. Liu and Xiu (2018) explored the dynamic circular interrelationship
along investments into R&D—a subcomponent of expenditure GDP—and economic growth,
along with technological innovation in China. The paper by Mohamed et al. (2014) delved in a
part of the topic that we address in this paper. They explored the causal relationship between total
exports and imports of goods and services in Tunisia and found that there’s bilateral causality
between the two components. All these results from the above studies offers important
macroeconomic insights into the interdependencies of economic growth’s factors. Mohamed et al.
(2017) especially implied that Tunisian policymakers should focus on the imports of capital goods
into the country in order to maintain aggregate output and keep exporting, as well as to adopt more
structural reforms to improve export capacity.

Nevertheless, there has been some extensions of the causality between different components of
GDP. Empirical studies into the causalities between exports and imports similar to Mohamad et
al. (2017) has been conducted on different economies. Meyer and Sanusi (2019) conducted a
causality analysis between domestic employment, gross fixed capital formation—which is,
essentially, domestic business investments—and economic growth in South Africa. They found a
bidirectional causality between employment and economic growth, while the causality between
business investments to employment is unidirectional. Sinevičienė (2015) found evidence of the
crowding-out effect in economics where government expenditure does not positively impact
private investments using Granger causality test and cross-correlation; it then reveals the causal
relationship between the two components of GDP on five economies’ time-series data. Results
remain to consider different countries.

Despite great success with Granger causality testing, alternatives causality tests have been created
due to certain weaknesses of the Granger causality test. Gujarati (2005) highlighted the
vulnerability of Granger’s test by its sensitivity to the number of lags, which can be significant.
Furthermore, since the condition of time-series stationarity is required in order to conduct a
Granger causality test, most time-series are then vulnerable to not qualifying, since most are often
nonstationary (Maddala 2001). Further transformations of time-series such as first differencing is
also unreliable because the F-statistic will then follow a nonstandard distribution (Gujarati 2006).
Fortunately, Toda and Yamamoto (1995) devised a method for resolving this problem with the
estimation of a bivariate VAR model, under the null hypothesis that there are no Granger
causalities between the two variables.

Per country choice, we chose Austria due to mostly testing reasons with its extensive breadth of
data as from the IMF. We envision that the method be applied to any economies’ data given a large
enough size. Some noteworthy studies have been done in many countries. One particular example
is studies done on Malaysia. Studies has been conducted on pairwise Granger causalities between
certain GDP components of the country. Much research seems to focus on the particular industry
of electricity in Malaysia as they study the electrical consumption-growth nexus. A few of those
are Tang (2008), Chandran et al. (2010) and Yoo (2006). Karim et al. (2012) took an aggregate,
non-sectoral view on consumption and studied the co-causalities between fixed investments,
household consumption and economic growth using a Structural Vector Error Correction Model
(SVECM); they concluded that long-run growth can only be affected with supply-side policies
which needs neither stimuli on fixed investment or household consumption, to which the latter
only significantly impacts short-run economic growth. With Austria-specific studies, some works
were done to find causalities between economic components. Afonso and Rault (2009)
investigated the existence of Granger causality between current account deficit and government
budget deficit in EU and OECD countries, but found no causal relationship for Austria. Gómez
and Giráldez (2017) conducted research on the effect of immigration on economic growth and vice
versa on EU/EFTA members, but also didn’t find any causality between the two economic
variables for Austria.

Data:
We use panel yearly data of Austria’s quarterly GDP components from International Monetary
Fund (IMF) from the first quarter of 1996 to the third quarter of 2019 (95 datapoints). The size of
the data then allows for justifiable statistical analysis. We took a logarithmic transformation on the
levels of the data in order to eliminate heteroscedasticity. Indeed, one can imagine that there exists
increasing variance in the GDP components over time due to the natural trending growth of an
economy.
We then employ a pairwise panel Granger causality test via Toda-Yamamoto’s procedure between
the components of the non-seasonally adjusted nominal GDP, which consists of five components:
• NCP: Nominal Household Consumption Expenditure
• NCGG: Nominal Consumption of Government
• NFI: Nominal Gross Fixed Capital Formation
• NX: Nominal total export
• NM: Nominal total import

Methodology:
The reason we chose to use Toda-Yamamoto’s method is due to the non-stationarity we exhibited
arbitrarily in the levels of the components of GDP. We then seek the maximum order of integration
𝑑 of the time-series variables using a cross-check between the Augmented Dickey-Fuller (ADF)
and the Kwiatkowski–Phillips–Schmidt–Shin (KPSS) test. Our results are summarized in Table 1.

We then proceed to estimate the following bivariate VAR model.

,-. ,-. (1)
𝑋# = 𝛼& + ( 𝛽&* 𝑋#+* + ( 𝜃&1 𝑌1+* + 𝜖&#
*/& 1/&

,-. ,-. (2)

𝑌# = 𝛼4 + ( 𝛽4* 𝑌#+* + ( 𝜃41 𝑋1+* + 𝜖4#
*/& 1/&

Here, 𝛼, 𝛽, 𝜃 are constant coefficients. 𝑋# and 𝑌# are the two time-series that we are looking for
possibly bidirectional or unidirectional Granger causalities. 𝜖# are the individual error terms of the
two VARs which are assumed to be non-autocorrelated white noises with zero means and constant
variance. With our case, we are to conduct the Toda-Yamamoto procedure pairwise on the lists of
five GDP components. There will then be ten procedures done. To determine the lag length 𝑝, we
use three common information criteria as model selection criteria—Akaike Information Criterion
(AIC), Bayesian Information Criterion (BIC), Hannan-Quinn’s Criterion (HQ), and the Final
Prediction Error (FPE). We used the asymptotic Breusch-Godfrey LM test to test for serial
correlation in our VAR models with the augmented lag 𝑝 + 𝑑, under the null hypothesis that
there’s no autocorrelation for that model pair with that augmented lag. Our results are summarized
in Table 2.
 Findings:
KPSS ADF Maximum order of
integration
(𝑑)
NCP I(1) I(1) 1
NCGG I(1) I(2) 2
NFI I(1) I(1) 1
NX I(1) I(1) 1
NM I(1) I(1) 1
Table 1: Maximum order of integration as determined jointly by KPSS and ADF

VAR model NCP- NCP- NCP- NCP- NCGG NCGG- NCGG NFI- NFI- NX-
pairs NCGG NFI NX NM -NFI NX -NM NX NM NM
0.00763
BG-LM 0.9829 0.8994 0.08498^ 0.3983 0.1948 0.3072 0.2176 0.1938 0.1855
**
p-value (p = 3) (p = 4) (p = 5) (p = 5) (p = 2) (p = 6) (p = 5) (p = 2) (p = 2)
(p = 2)
Table 2: Breusch-Godfrey LM test’s p-values

Causal
NCP NCGG NFI NX NM
NCP 0.01651* 0.1136 0.1042^ 0.03475*
(p = 3) (p = 4) (p = 5) (p = 5)

NCGG 0.06358^ 0.9838 0.04617* 0.1881

(p = 3) (p = 2) (p = 6) (p = 2)
NFI 0.01818* 0.7005 0.009926** 0.368
(p = 4) (p = 2) (p = 5) (p = 2)

NX 0.217 0.05083*^ 0.03125* 0.08947^

(p = 5) (p = 6) (p = 5) (p = 2)

NM 0.01735* 0.6262 0.1151 1.126e-07

(p = 5) (p = 2) (p = 2) *** (p = 2)

Table 3: p-value table of pairwise causality

(Significance levels: (**): 0.01 (*): 0.05 (^): 0.1)

From Table 2, we see that all VAR pairs except for NCGG-NM are accepted to be non-
autocorrelated under the null hypothesis. NCGG-NM are then not suitable to move on with Toda-
Yamamoto procedure. We marked this red in Table 3 to indicate non-suitability.

With results from Table 3 above, several interesting insights can be drawn upon the cross-
causalities between the components. Firstly, we can see three bidirectional causality running
between the pairs of NCGG-NX, NFI-NX and NCP-NM, all with rejection of the null hypothesis
of no causality at the 0.05 significance level and under. These pairs are important to understand.
Regarding NCGG-NX, it shows that government spending Granger-causes exports, and exports
also Granger-causes back. This may indicate that there must be some links between increasing
government spending and a facilitation of exporting, which might be from the increase in
production output of domestic firms; this realization may be justified with the likewise
bidirectional causality of government expenditure to business investments (NCGG-NFI) in form
of gross fixed capital formation. However, NCGG-NFI relationship is bidirectionally non-causal
as the null hypothesis was not rejected on any acceptable significance level; the impact of
government expenditure on export is then not caused by the presence of the facilitation of output
by government subsidies. We then leave this realization for future research to reconcile.

The second pair of causality with NFI-NX is perhaps the clearest causality we can see. As
businesses make more investments, capitals formation increases and from there, output also
increases, leading to possibly more incentive to export and find better foreign markets. The other
causality from NX to NFI is less strong with the p-value very close above the 0.05 significance
level. We may not conclude any causality between the two components.

The NCP-NM bidirectional causality is also an explainable. A higher level of consumption would
increase imports as more needs and wants are to be satisfied. Initial increases in consumption
would also signal the foreign producers outside of Austria to increase their export to the country
in hope of obtaining more revenue. This is not in consideration of any changes in barriers-to-entry
such as changes in tariffs, quotas or any VERs that would introduce exogenous impacts on the
non-Austrian producers’ decision to increase exports.

Addressing the other unidirectional causalities, there are NCGGàNCP, NCPàNFI, NXàNM.
NCGGàNCP is fairly understandable; government’s spending would increase consumption on a
macroeconomic scale; this could be in the form of government expenditure on public goods and
services such as infrastructures. NCPàNFI is a fairly understandable causality. It can imply the
demonstration of a classical concept in demand-supply equilibrium in microeconomics, in that
supply will eventually match up with demand in order to meet equilibrium and function. Since
supply is directly related to business investments—a matter of input and output—on a
macroeconomic level, we see that businesses in economies, specific to ones in Austria and hence
this study, have to constantly purchase new capitals and human resources and invests in R&D in
order to stay competitive and gain consumers. The extremely low p-value of the NXàNM
causality can imply cointegration between NX and NM. It’s, however, interesting that the causality
is only unidirectional. Nevertheless, this implies that foreign trade is fairly matched between
Austria and their trade partners.

Conclusion:
We have conducted an empirical study into the pairwise causalities between the expenditure GDP
components using Austria’s quarterly panel data obtained from IMF’s database. Our results show
that there exists Granger causalities between the different components of GDP, with several
causalities being bidirectional and others being unidirectional. Some of the causalities were
explainable following an economic perspective, but there still exists some ambiguity in the
causalities such as the NCGG-NX relationship as explored.
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