Provincial fiscal positions and business cylce synchronization across China

This paper examines to what extent Chinese provinces with similar fiscal policies have synchronous business cycles. Following Darvas, Rose, and Szapáry (2007), we create a measure of fiscal policy divergence between provinces i and j and see if it is associated with the correlation of output movements between i and j. To examine this relation, we use the correlation model of Frankel and Rose (1998). Since causation can run from both fiscal policy to output fluctuations and from output fluctuations to fiscal policy, we instrument for fiscal policy using government expenditure on cultural activities which remains steady across the business cycle. Results show that provinces with similar budgetary positions tend to have similar business cycle movements.