The Asymmetric Effects of Government Expenditure Shocks on the Financial Cycle of Business Cycles with an Emphasis on Islamic Participation Bonds Using the NARDL Model

Abstract

The present article examines the asymmetric effects of government expenditure shocks on the financial cycle of business cycles, with an emphasis on Islamic participation bonds, using the NARDL model. The research method is applied in terms of purpose and descriptive–analytical in nature, falling within the category of post-event studies (using historical data for the period 1987–2023). In this regard, nonlinear NARDL models were employed to investigate short-term and long-term relationships between government expenditures, financial cycle indices, and other macroeconomic variables. The primary focus of the research is on a precise analysis of positive and negative fluctuations in current and capital expenditures and their impact on the performance of the financial cycle and the country’s business cycles. The short-term estimation results indicated that positive shocks in current and capital expenditures increase the financial cycle, whereas negative shocks in these expenditures have opposite and weakening effects. This asymmetry clearly demonstrates the existence of nonlinear relationships between government expenditures and the financial cycle, which holds particular importance in fiscal policymaking. In other words, the financial cycle responds differently and more strongly to increases in government expenditures compared to decreases. Furthermore, the coefficients related to other macroeconomic variables, such as gross domestic product, investment, and interest rates, were negative and statistically significant, indicating that increases in these variables reduce the financial cycle in the short term. In contrast, inflation and consumption showed a positive and significant effect on the financial cycle. The error correction coefficient (ECM) was negative with a relatively high magnitude (approximately –0.72), suggesting that the speed of adjustment from short-term deviations toward long-term equilibrium is considerable and that the model has good predictive capability. Diagnostic tests also confirmed that the model does not suffer from heteroscedasticity, autocorrelation, or specification errors, thereby enhancing the validity of the results. In the long term, the results of the cointegration model confirmed the existence of a stable and significant relationship between government current and capital expenditures, macroeconomic variables, and the financial cycle. The long-term coefficients exhibited patterns similar to the short-term findings, with asymmetric effects of government expenditures on the financial cycle being evident over the long horizon as well. Structural stability tests, including CUSUM and CUSUMQ, confirmed that the model did not experience structural breaks during the study period, thus ensuring the stability and reliability of the results. Based on these findings, it is recommended that fiscal policymakers consider the asymmetric effects of current and capital expenditures and utilize Islamic financial instruments such as participation bonds for government financing. These instruments, while providing sustainable financial resources, can help control asymmetric expenditure fluctuations and improve the efficiency of managing the financial cycle and business cycles of the country.