Erasmus University Rotterdam
Erasmus School of Economics
Master Program: Policy Economics
Master Thesis for the completion of the Policy Economics Master Program
Student Name: Periklis Revelos,
Student Number: 373218
e-mail: 373218pr@student.eur.nl
Phone number: +31 645575967
“The validity of Ricardian Equivalence Hypothesis. A comparative analysis for the high and low
government debt European Countries”
Supervisor: Professor Mr. Casper De Vries
1
“The Validity of Ricardian Equivalence Hypothesis. A comparative Analysis for
high and low government debt European countries”
Abstract:
Having theoretically approached the Ricardian Equivalence Hypothesis analyzing the
underlying assumptions and the proposed estimation approaches and having reviewed the
relative existing literature we used the long run consumption function developed by Berben and
Brosens (2007) in order to investigate the impact of government debt on private consumption
and hence test the Ricardian Equivalence proposition for different levels of debt. In our analysis
we studied both the long run and short run effects of public debt (incorporating the consumption
function in an ADRL model). According to our main results the Ricardian Equivalence
Hypothesis was rejected both for the high and low indebted countries since the government debt
coefficient was positive and statistically significant though less potent for the high debt
countries. On the contrary, the short run effects results revealed that individuals especially in
high debt countries obtain Ricardian characteristics.
Introduction:
The governments in regular times have two kind of policies in their disposal in order to stabilize
their economies and to enhance growth. The first Policy is referring to the Fiscal and the second
to the Monetary policy. The Fiscal Policy involves the determination of taxes and government
spending to affect the aggregate demand and hence the economic activity in the desirable way,
while the Monetary policy incorporates the tools of money supply and either the interest rate or
inflation targeting. Though, within the borders of a Monetary Union as in the case of European
Union, the states lose the control of their Monetary Policy tools, since this kind of Policy is
conducted by the central bank and in the case of the European Union by the European Central
Bank (ECB).
The aim of this master thesis is to assess the impact of the government debt parameter on private
consumption testing the validity of the Ricardian Equivalence proposition and hence indirectly
the effectiveness of fiscal policy. Due to our panel data estimation approach we were able to test
the effects for different levels of public debt classifying the major European countries in high
and low public debt economies1.
Lately and especially nowadays with the escalation of the problem regarding the Greek economy
which sinks under the burden of its unsustainable public debt there is a growing interest for the
government debt parameter in the Macroeconomic studies. Global financial institutions e.g. the
IMF, Central Banks and the Ministries of Finance all over the world incorporate in their analyses
the government debt parameter focusing on its sustainability and its impact on the economic
growth and on the effectiveness of the Fiscal and Policy Measures.
Master Thesis Outline:
In section one we define the Ricardian Equivalence Theorem while in the second section we
provide the Ricardian Equivalence result by David Romer. At chapter three, four and five we
1
Taking into consideration the Dept to GDP ratio.
2
analyze the assumptions that ground the Ricardian Equivalence Hypothesis, we develop the
literature review and the main approaches that have been suggested for testing the Ricardian
Equivalence proposition. At section six we proceed with our preliminary testing based on the
graphical and quantitative analysis of the public, private and national savings, while at section
seven we perform the main quantitative analysis estimating our consumption function both
individually for every country and also in aggregate level for different group of countries based
on their debt level using panel estimation techniques. Finally, chapter eight concludes, while
sections nine and ten comprise the references and the appendix respectively.
1. The Ricardian Equivalence Theorem
On regular circumstances a government has two ways to finance its government expenditures
either by increasing taxes or through debt issuing. According to the Ricardian Equivalence
Theorem the effects of these two financing options on the consuming behavior of the individuals
and hence aggregate demand are the same. According to Barro (1989) these two financing
options are equivalent. For this reason the Ricardian theorem is called Ricardian Equivalence
theorem. Specifically, according to the Ricardian Equivalence Hypothesis the consuming pattern
of the individuals is not affected by the choice that the government makes in order to finance its
expenditures. Since consumers are forward looking, they realize that possible tax cuts/ debt
issuing now will create tax liabilities in the future and so they do not alter currently their
consuming behavior increasing their consumption. On the contrary, in the case of tax cuts
individuals save the amount of taxes not paid currently while in the situation of debt financing
the value of bonds plus the interest rates that will be paid when the bonds will expire in order to
cope with the increased future tax liabilities. Hence, the main point in the Ricardian Equivalence
theorem is that individuals do not perceive government debt as net wealth and hence do not
change their consuming behavior.
The logic of the Ricardian Equivalence Theorem belongs to David Ricardo, one of the most
influential classical economists. In his work the “Funding System” an article in the supplement
to the fourth, fifth and sixth editions of the Encyclopedia Britannica (1820) he grounded the idea
that there is not a substantial difference between the two ways of financing the government
expenditures through tax cuts or borrowing. According to his example, a country involved in a
war could finance its expenditures either by increasing taxes or by borrowing without
considerable differences for the economy as a whole.
The fundamental paper for the Ricardian Equivalence Theorem is the one of Barro (1974) with
the title: “Are Government Bonds Net Wealth?”. At his paper Barro applied a version of the
Samuelson (1958) and Diamond (1965) model of overlapping generations with physical capital
and finite lives in order to investigate whether the government debt issue is perceived as net
wealth by the households and so affecting their consuming behavior.
Barro (1974) mainly found that in the case of government debt issue there would be no net
wealth effect and hence an effect on aggregate demand when the current generations act as they
are infinitely lived and are connected with the future generations through a “chain of operative
intergenerational transfers”. In the case of debt issue, current generations realize that due to
future taxation the tax burden would be higher for the prospective generations, and hence they
3
leave them positive bequests in order to alleviate the increased future tax burden. As a result
current generations do not perceive the government debt as net wealth, and hence they don’t
increase current consumption leaving unaffected the aggregate demand.
Furthermore, Barro assessed the impact of the imperfect capital markets and liquidity constraints
on the specific issue. According to his findings, the net wealth effect can be positive if the
government is more efficient in the “lending and borrowing” procedure. Additionally,
concerning the liquidity constraints, there will be no wealth effects due to the bonds issue if the
households are not liquidity constrained, but the corresponding effect will be positive if
households face limitations in liquidity services.
2. The Ricardian Equivalence result by David Romer
Romer (2012) in his book Advanced Macroeconomics analyzed the Ricardian Equivalence result
based on Ramsey – Cass - Koopmans model with lump sum taxation. The model assumes that in
the case of taxes the household budget constraint is as follows:
∞
∞
∫ 𝑒 −𝑅(𝑡) 𝐶(𝑡)𝑑𝑡 ≤ 𝐾(0) + 𝐷(0) + ∫ 𝑒 −𝑅(𝑡) [𝑤(𝑡) − 𝑇(𝑡)]𝑑𝑡
𝑡=0
(1)
𝑡=0
Where, C(t) is consumption, W(t) the labor income, T(t) the taxes, while K(0) and D(0) stands
for the quantities of the capital and government bonds at time 0. The logic of the budget
constraint is that the present value of the consumption cannot exceed the initial quantities of
capital and government bonds plus the present value of the labor after tax income.
The household budget constraint can also be written:
∞
∞
∞
∫𝑡=0 𝑒 −𝑅(𝑡) 𝐶(𝑡)𝑑𝑡 ≤ 𝐾(0) + 𝐷(0) + ∫𝑡=0 𝑒 −𝑅(𝑡) 𝑊(𝑡)𝑑𝑡-∫𝑡=0 𝑒 −𝑅(𝑡) 𝑇(𝑡)𝑑𝑡
(2)
Assuming that the government satisfies its budget constraint with equality meaning that the
present value of taxes equals initial debt plus the present value of the government purchases we
can write:
∞
∫ 𝑒
∞
−𝑅(𝑡)
𝑇(𝑡)𝑑𝑡 = 𝐷(0) + ∫ 𝑒 −𝑅(𝑡) 𝐺(𝑡)𝑑𝑡
𝑡=0
(3)
𝑡=0
Where G(t) stands for the government purchases. Additionally the household budget constraint
can be written as follows:
∞
∞
∞
∫𝑡=0 𝑒 −𝑅(𝑡) 𝐶(𝑡)𝑑𝑡 ≤ 𝐾(0) + ∫𝑡=0 𝑒 −𝑅(𝑡) 𝑊(𝑡)𝑑𝑡-∫𝑡=0 𝑒 −𝑅(𝑡) 𝐺(𝑡)𝑑𝑡
(4)
From the household budget constraint we can notice that the present value of the consumption is
determined by the quantities of the capital bonds at time 0, the present value of the labor income
as well as and the present value of the government expenditures. In the latest form of the
household budget constraint we can perceive that the consumption decisions are affected by the
government expenses and not from the taxes and bond issues, the two main ways that the
government can use in order to finance its expenditures. The crucial point here that is consistent
with our previous analysis is that the consumer behavior is not affected by the ways that the
government chooses each time to finance its expenditures.
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3. Assumptions – Debate followed
In order to theoretically and empirically ground the Ricardian equivalence theorem Barro (1974)
used a number of strict assumptions explicitly stated at the study of Bernheim (1987) that
provoked fierce criticism and debate among economists even recently. The studies followed the
fundamental paper of Barro2 (1974) examined the validity of Ricardian proposition focusing on
different assumptions each time. Though, the majority of the studies converged to the following
assumptions:
The households are intergenerationally linked through altruistic transfers
Barro (1974) used the assumption that when generations are linked through “a chain of operative
intergenerational trasnfers” the increase in government debt through bonds issue is not perceived
by the current generation as net wealth increase and hence has no effect on consumption and
aggregate demand. The reasoning behind this argument is that since the current generation
knows that the government bond issue will raise the need for future taxes so as the debt increase
to be paid back is not increasing its current consumption. Contrary, being altruistically
motivated, current households prefer to make a transfer to their descendants to alleviate their
increased taxes burden and hence act as infinitely lived. According to Barro, these transfers
could not only take the form of bequests but also the form of parental expenses towards their
children needs3. Additionally, these transfers could also work at the opposite direction, as gifts
from children to their parents. In case this assumption does not hold current households care only
for their own welfare, make no transfer to their offspring and hence increase their current
consumption invalidating the ricardian equivalence proposition.
The criticism to this assumption started with Feldstein (1976) who stated that Barro omitted from
his analysis the role of economic growth. Feldstein stressed that when the national income
increases with a rate higher than the interest rate of the government debt 4, the government can
increase its debt without imposing future taxes by paying the government debt interests issuing
new debt5. In this case the government debt increases with the rate of interest rate lower than that
of the economic growth. Accordingly, current generations that realize that the debt increase will
not be followed by future taxes, leave no bequests at their descendants increasing their current
consumption. Referring to the intergenerational transfers Feldstein pointed that these
transferences do not reflect transfers of real capital described by bequests but take mostly the
form of consumption support from parents towards their children at their early age.
In this direction Bernheim (1987) pointed that parents choose to leave no bequests at their
children. When there are parent-child linkages all the individuals are incorporated in an
2
“Are government Bonds Net Wealth”.
E.g. for Educational purposes.
4
Which reflect the cost of government debt.
5
This case is described by the rolling over the debt term. Feldstein in his analysis did not use the assumption that
the debt has to be paid back.
3
5
“interconnected network” where the consumption of each member is based on the total wealth.
Hence, as the increase in bequest is devided to all the involved members leaving their
consumption almost unaffected, the parents prefer to avoid making bequests. He concluded that
only few individuals make some or not intentional transfers for reasons other than altruistic such
as for exchange purposes making the Ricardian Equivalence not to hold. Later on Feldstein
(1988) referring to Feldstein (1982) stressed that operative bequests are rare since the marginal
utility of parents consumption during the retirement period is higher than the marginal utility
deriving from a possible bequest to their children. Furthermore, he added that beyond the
altruistic motivated bequests there are other bequest motives such as strategic and stewardship
bequests with different levels of altruism that have ambiguous effects on current consumption
and hence the validity of Ricardian Equivalence hypothesis. While the purpose of the strategic
bequests6 is to make sure that the parents will keep receiving the attention and care from their
children in the case of stewardship bequests individuals considering themselves as stewards
make bequests to their children at least of the same amount of the bequest that they inherited
from their parents.
Seater (1993) accepted the operative altruistic bequests as one of the fundamental conditions for
the Ricardian Equivalence to hold. Although, the author emphasized that altruism is absent at
other form of bequests such as the strategic and accidental bequests, rendering ambiguous the
validity of the Ricardian equivalence hypothesis. Specifically, at strategic bequests parents use
bequests as a mean to keep receiving attention from their children, threatening to disinherit them
in different case. At the other side children may threaten their parents that may act in a way that
reduces their welfare and hence their parents welfare unless if the later are generous enough.
Accidental bequests occur when individuals die earlier than they expected leaving their assets to
their offspring. In addition, although Seater accepts the existence of bequests admits that the
level of altruism in determining the bequests is not clear. Regarding the two sided altruistic
regime7 the author stressed that while earlier studies showed that such a regime could validate
Ricardian Equivalence, later studies revealed a cycling problem in the model’s solution
offsetting Ricardian proposition. Though, Seater noted that the altruistic transfers from offspring
to their parents are negligible in comparison with those of the opposite direction. Childless
families according to Seater that constitute a considerable fraction8 of the overall families
invalidate the Ricardian Equivalence since having no concerns for the taxes imposed on future
generations increase their current consumption as a result of a debt issue.
Barro (1989) reacted to the objections raised regarding the assumption of operative altruistic
bequests stating that despite the existence of other forms of bequests beyond the official ones
they are still operative and hence support the Ricardian Equivalence hypothesis. In the case of
6
Introduced by: Kotlikoff and Spivak (1981) and Bernheim, Schlaefer and Summers (1984).
This regime includes altruistic bequests from parents to their descendants and altruistic gifts from children to
their parents.
8
One fifth of the overall families were childless.
7
6
childless families the author pointed that the aggregate effect on private consumption caused by
debt issue will be negligible due to the offsetting behavior of the families with more than the
average number of descendants that will increase the bequest towards them. Referring to altruism
Barro mentioned that the relationship between parents and children is better described by
altruism and not by strict market terms that regard bequests as wages for the services that
children provide to their parents. Additionally, the author concluded that strategic bequests with
credible threats can also make the Ricardian proposition to hold.
Perfect capital markets - no liquidity constraints
This assumption about the credit markets signifies that consumers are not credit constrained. In
case of borrowing limitations consumers cannot smooth their consumption and hence increase
their current consumption as they perceive the debt issue as net wealth. As a result, the Ricardian
Equivalence framework cannot be supported. Barro (1974) highlighted that net wealth effects
arise in the case of debt issue when the government is more efficient9 than the private markets in
the borrowing procedure. Moreover, Barro investigated the effects of liquidity services provision
from the government under different levels of market power and found that debt issue induces
positive net wealth effects when the government acts like a Monopolist. On the contrary, when
the government behaves competitively or oversupplies liquidity the wealth effects are zero and
negative respectively. In the case of positive and negative wealth effects the Ricardian
Equivalence is not supported.
Heller & Star (1979) examined the role of borrowing limitations on consumption and found that
for a specific time period credit constrained households base their current consumption decisions
on disposable income even in anticipation of higher future incomes after that period. The
increased future incomes though increase the amount of wealth currently cannot eliminate the
credit barriers. Hence, the authors concluded that when credit constraints are binding the debt
finance fiscal policy is more effective in stimulating consumption.
Barro (1989) at his later paper examined more extensively the necessity of perfect capital
markets as precondition for the validity of the Ricardian proposition and concluded that
imperfect capital markets was not a sufficient condition for the neutrality hypothesis not to hold.
Instead imperfect capital markets are a source of failure for the Ricardian theorem only if the
government intervenes in the loan market with better terms than those provided by the private
market. The government interventions in the loan market occur through the budget deficit
channel and when this happens with better terms than those of the private sector wealth effects
raise invalidating the neutrality hypothesis.
Seater (1993) agreed with the findings of Barro (1989) pointing that the existence of credit
constraints is itself insufficient to abolish the Ricardian proposition. The author agreed with the
conclusion of Hayashi (1987) and Yotsuzuka (1987) that the effects of borrowing barriers on the
Ricardian Equivalence depend on the source of these constraints. According to Seater the
superiority of the government in loan markets as previously described by Barro (1989) could
9
The efficiency term refers to the tradeoff between the economies of scale and informational advantage benefits
and the control costs.
7
take the form of lower transaction costs and the limitation of the adverse selection problem. In
these cases the debt issue alleviates the problem of credit constraints, yields wealth effects and
hence makes the Ricardian equivalence hypothesis to fail. Contrary, when borrowing constraints
derive from future incomes uncertainty, debt issue that is not affecting the income uncertainty
leaves the liquidity constraints unaffected and hence the neutrality hypothesis still holds.
Cox & Japelli (1990) studied the relationship between borrowing constraints and
intergenerational transfers and revealed a positive relationship between them. Specifically, they
found that liquidity constrained individuals are more likely to receive a transfer than individuals
with access to credit market. Though, the transfers were sufficient to eliminate the credit
rationing problem for only a small fraction of the credit constrained individuals.
More recently Rohn (2010) stressed the importance of liquidity unconstrained individuals as a
precondition for the validity of Ricardian Equivalence proposition. Rohn found that when
financial markets are more developed in the sense of credit barriers absence, private savings
offsets are more robust following a change in fiscal policy. On the contrary when individuals
face borrowing constraints the savings offsets are weaker as individuals use the debt financed tax
cuts which imply raise on their disposable income to increase their consumption. Hence, the
author concluded that in cases of credit barriers Ricardian hypothesis does not hold while fiscal
policy becomes more potent.
The taxes should be lump-sum, not distortionary
This assumption implies that the amount of tax imposed on households should be fixed and not
determined according to their income. This assumption is considered to be very strict since the
majority of taxes in the real world are progressive which means that are set according to the
income level, for example the income taxes. Barro (1974) based his findings regarding the
validity of Ricardian Equivalence proposition assuming lump-sum taxes in order the interest
rates arising from the debt issue to be paid back. To this end Chan (1983) when using the
assumption of lump-sum taxes accepted the Ricardian Equivalence proposition while when
leaving the tax burden to be positively correlated with the income he found opposite results since
according to his findings current consumption increased.
Barro (1989) elaborated more on the assumption of lump-sum taxes using an example with
income taxes with the assumption of absent expenditures taxation to show that budget deficits
change the timing of taxes and hence affect the economic decisions of the individuals.
Specifically, a decrease in labor income tax the current period followed by an equivalent increase
the next period incentivizes individuals to work more the current period and less the latter one.
As a result the national savings will increase the current and will follow the opposite pattern the
next period invalidating the Ricardian Equivalence proposition. Concerning the latter argument,
Seater (1993) expressed a different opinion trying to disconnect the validity of Ricardian
equivalence and the changes of marginal tax rates. Seater stated that what matters for the
Ricardian proposition’s validity is the path of debt and not the path of marginal tax rates
stressing that a change in debt is not necessarily accompanied by changes in marginal tax rates.
8
Hence, changes in economic decisions of the individuals caused by marginal tax rate changes do
not necessarily imply invalidation of Ricardian framework.
Certainty about future tax liabilities and incomes
This means that individuals should anticipate with certainty both the future incomes and the tax
liabilities derived from the government debt interest payments. According to Barro (1974)
uncertainty in tax liabilities increases the risk in the household’s balance sheet and hence
decreases the household wealth. As a result the household tend to increase its savings. On the
contrary when the variations of tax liabilities derive from changes in income, tax variations
decrease the volatility of disposable income and hence the uncertainty of the household balance
sheet disincentivizing savings. Consequently Barro stressed that the overall impact of tax
uncertainty on household risk and hence consumption is ambiguous and dependant on the nature
of the tax system.
Chan (1983) reached to similar conclusion as Barro. Specifically, he found that uncertainty about
the future taxes induces income uncertainty which leads to increased savings and hence
decreased consumption. For taxes that change according to the income level the author pointed
that while lead to increased current consumption due to the decrease in income uncertainty the
overall outcome is ambiguous. Barro (1989) elaborated more on the findings of Chan (1983) and
concluded that budget deficits raise the uncertainty level imposed on the individual disposable
income making people reduce their consumption thus increasing their savings by more than the
tax. On the other side, in the case of income taxation, budget deficits decrease the income
uncertainty “as the government shares more risks about the individual disposable income” with
adverse results on consumption and savings. Hence, in these cases Ricardian Equivalence
Hypothesis does not hold since the budget deficits exert wealth effects.
Feldstein (1988) investigated the role of future income uncertainty specifically on bequests.
Feldstein found that future incomes uncertainty renders uncertain also the bequests leading the
current consumption to increase. Using a numerical example he showed that the introduction of
income uncertainty makes the current consumption, the savings for precautionary reasons and
the bequests to increase. Most importantly, under the regime of deficit financed tax cut and
income uncertainty, the current consumption raises and so the bequests though not sufficiently to
compensate the next generation for the welfare loss imposed by the taxation burden. As a result
the Ricardian Equivalence does not hold.
The consumers have to be rational and farsighted
This assumption implies that individuals should take their economic decisions based on available
information about the future and not only the present. This means that in the case of debt issue
rational and farsighted individuals anticipate increased future taxes deriving from the
9
government debt repayment and so adjust their behavior accordingly. Hence, they do not
increase their current consumption but instead increase their savings in order to make bequests to
their descendants offsetting in this way the welfare loss imposed to them by the future tax
burden. The debate followed the foresight assumption started from David Ricardo (1820) himself
who established the theorem of Ricardian Equivalence. Specifically, David Ricardo at his notes10
on his fundamental paper “Funding System” expressed doubts on if individuals base their
economic decisions taking into consideration the tax payments stating that the individuals “never
estimate the taxes that they pay and hence do not manage accordingly their economic cases”.
Bernheim (1987) described the rationality as an “in vogue” assumption noting that in case
individuals fail to incorporate in their economic decisions the future tax liabilities deriving from
the budget deficit they base their consumption on the current disposable income. Hence the
Ricardian Equivalence does not hold and the economy obtains Keynesian characteristics. To this
end Modigliani & Sterling (1990) investigating the effects of temporary and permanent taxes on
consumption found that individuals define their disposable income, wealth and consumption
level ignoring the government expenditures and the budget deficit. These finding in line with the
doubts of David Ricardo (1820) described above were against the Ricardian Equivalence
proposition which implies that individuals base their economic decisions taking into
consideration the tax liabilities stemming from the fiscal policies of the government.
Seater (1993) that referred to the findings of Modigliani and Sterling commented as extreme the
rationality and foresight assumptions doubting the existence of a theory that could sufficiently
describe the behavior within the Ricardian Equivalence framework. More recently Chow (2011)
although admitted that rational expectations assumption was not necessarily incorrect as could be
applied in many cases, stressed the fact that rational expectations hypothesis was widely
accepted without adequate empirical evidence. Instead, Chow providing econometric evidence in
favor of the adaptive expectations hypothesis stated that this specific hypothesis was superior
than the rational expectations assumption as a proxy for psychological expectations in economic
behavior studies.
4. Literature review
After the initial enouncement of the Ricardian Equivalence proposition by David Ricardo on
1920 and the fundamental paper of Barro on 1974, a number of studies were performed in order
to test the validity of Ricardian Equivalence theorem applying various estimation methods and
using different group of countries. Due to this heterogeneity of the estimation approaches these
surveys yielded different and in many cases conflicting results. In this part we will report the
studies that focused mainly on the European countries and took into consideration the
government debt parameter.
10
David Ricardo’s notes on the Funding System. The Funding System was an article in the supplement to the
Fourth, Fifth and Sixth Editions of the Encyclopedia Britannica 1820 were the author introduced the proposition of
Ricardian Equivalence.
10
Afonso (2001) was the first that investigated the Ricardian Equivalence Proposition exclusively
for European economies11. Specifically, Afonso estimated private consumption Euler equations
that derived from the intertemporal consumer’s maximization problem first introduced by Hall
(1978), using a panel data approach for the period 1970-2000. As a first step he divided the
countries in two groups the “less indebted”12 and the “more indebted”13 based on the criterion
imposed by the Maastricht Treaty. Furthermore Afonso applied the fixed effects specification
due to the common characteristics of the countries in the sample. According to his main findings
the Ricardian Equivalence proposition was rejected for all the countries in the sample as a
positive relation between government debt and the private consumption was revealed. In
addition, while for moderate levels of debt the effect of government debt on private consumption
was considerable, for higher debt levels the impact on private consumption was more moderate
leading to the conclusion that in high debt countries: “consumers might become more
Ricardian”. According to Afonso’s estimations a government debt increase of 1000 Euros rise
private consumption by 44 Euros in low debt countries and by 29 Euros in the more indebted
countries. Furthermore, Afonso repeated the estimation process applying alternative thresholds
regarding the Debt to GDP14 ratio. The 50% threshold yielded statistically and quantitatively
more significant results regarding the government debt coefficient, suggesting that above the
50% debt to GDP ratio individuals are more concerned about the “future consequences of
government indebtedness”.
Reitschuler & Cuaresma (2004), tested the Ricardian equivalence hypothesis for 2615 OECD
countries for the period 1960-2002. Their estimation approach was based on the dynamic
optimizing agents theoretical model of Leiderman & Razin (1988) that was later developed by
Khalid (1996). This specific model was allowing for the existence of two types of consumers16
depending on their access to credit. The empirical analysis that Reitschuler & Cuaresma (2004)
followed was allowing them to directly test for the validity of the main assumptions implying the
Ricardian equivalence proposition that is whether the economic agents have infinite planning
horizons and the absence of liquidity constraints. The estimation of the model’s structural
parameters that was determining the validity of the Ricardian equivalence conditions was based
on the full information maximum likelihood. According to their estimations, the Ricardian
equivalence hypothesis could not be rejected for 10 out of the 26 OECD countries. Most
importantly the majority of these Ricardian economies17 were European. According to
11
EU-15: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal,
Spain, Sweden, United Kingdom. Luxemburg was excluded due to data availability problems.
12
If they experienced a Debt to GDP ratio below 60%
13
If the Debt to GDP ratio exceeds the 60%
14
Using the 50% and 70% debt to GDP ratio
15
The sample included countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece,
Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Portugal, Spain,
Sweden, Switzerland, Turkey, United Kingdom and United States.
16
Liquidity constrained and liquidity unconstrained consumers.
17
Denmark, Germany, Greece, Ireland, Luxemburg, Spain, Switzerland, Norway and Korea.
11
Reitschuler and Cuaresma “fiscal frameworks…in Europe may have led to reduced myopia
among European Households”.
Reitschuler & Cuaresma (2006) on their later work using the same theoretical model developed
by Leiderman & Razin (1988) tested the Ricardian equivalence proposition exclusively this time
for European countries18 for the period 1960-2002. Additionally Reitschuler and Cuaresma tested
for a structural break in the behavior of the individuals in the 1990’s due to the introduction of
the Maastricht treaty and the Stability Growth Pact applying the approach proposed by Andrews
and Kim (2003) to identify possible end of sample cointegration breakdown. As in their earlier
study they estimated the structural parameters of the model applying the full information
maximum likelihood. According to their main results, the Ricardian equivalence hypothesis was
accepted for the eight19 out of 15 European countries. Furthermore, the estimations for the
structural break in the behavior of the individuals were contradictory. Specifically, for France
and Netherlands while the REP was rejected for the pre break period, could not be rejected for
the post break period, leading to the conclusion that individuals became more Ricardian. On the
contrary for Austria and Ireland the authors revealed an opposite change of the behavior and got
no meaningful results for the rest of the countries. According to the authors the change in
behavior towards a more Ricardian perspective after the imposition of fiscal rules was attributed
to the fact that the consumers became more forward looking.
Pozzi et al. (2004) investigated the impact of government debt on the excess sensitivity of private
consumption applying the methodology of Campbell and Mankiw (1990) that was an extension
of Hall’s (1978) Euler equation approach and then they implemented panel estimation techniques
for a dataset of 19 OECD countries for the period 1990-1999. The motivation of their study was
to reveal the main factors that were determining the excess sensitivity of consumption especially
in situations of high government debt. According to Pozzi et al. (2004) in the cases of high
government debt the fraction of liquidity constrained consumers increases and at the same time
the fraction of myopic consumers decreases. Hence, the final effect on the excess sensitivity of
consumption is equivocal since the increase in liquidity constrained individuals tends to raise the
excess sensitivity of consumption while the decrease in the number of less forward looking
consumers exerts the opposite effect. Regarding the financial liberalization, the expected effect
on the excess sensitivity of consumption is negative since the financial liberalization reduces the
credit constraints. Pozzi et al. (2004) revealed a negative relation between changes in
government debt to GDP ratio and the amount of credit provided at the private sector. The main
result of the study was that an increase in the government debt level raises the excess sensitivity
of consumption due to the rise of the liquidity constrained consumers fraction. The opposite
effect caused by the decrease in the myopic consumers is being entirely offset by the liquidity
constraints effect. Regarding the results for the financial liberalization parameter the authors
didn’t reveal a significant negative relation between the financial liberalization and the excess
18
19
EU-15.
Austria, Belgium, Denmark, Spain, Germany, Greece, and Italy.
12
sensitivity of consumption. According to the authors at high government debt cases fiscal policy
becomes more effective20 obtaining Keynesian characteristics21.
Hogan (2004) tested the validity of the Expansionary Fiscal Contractions Hypothesis 22using
consumption functions for 18 OECD countries for the period 1970-1999. Hogan, rejected the
choice of the panel data estimation approach and especially the fixed effects for concerns related
to inconsistency. Following Pesaran and Smith (1995), he applied the Mean Group estimator.
According to Hogan (2004), the assumption that the impact of fiscal policy on private
consumption is the same in different countries is not valid. The logic behind this study is that
when government debt is at unsustainably high level, individuals increase their savings and
hence decrease consumption on anticipation of the forthcoming crisis. In this case a decrease in
the deficit that could change the expectations of individuals regarding the avoidance of the crisis
could be expansionary. The estimation results showed that an increase in taxation yielded a
statistically significant raise in private consumption contributing to the validity of the EFC
hypothesis. On the contrary, the statistical significant and positive relation between the
government and the private consumption found was against the EFC hypothesis. Accounting for
the debt parameter on the effectiveness of fiscal policy Hogan examined two cases regarding the
level of debt23. According to his results, while in the low debt case an increase in the government
consumption was followed by a raise in the private consumption, in the high debt cases this
relation turned negative leading the private consumption to decrease. The interpretation behind
the later result that supports the hypothesis of the expansionary fiscal contractions, is that when
the government debt is already in high level and the government consumption increases the fiscal
crisis escalates leading the individuals to reduce their private consumption and increase their
precautionary savings.
Berben & Brosens (2007)24, investigated the role of government debt on the effectiveness of
fiscal policy using data for 17 OECD countries for the time period 1983-2003. Specifically,
Berben & Brosens (2007) estimated how the level of government debt affects the private
consumption by applying the panel data estimation approach assuming the same long run
consumption function for all the countries in their sample. Additionally, in order also to
investigate the short-run effects they incorporated this relationship in an autoregressive
20
Fiscal multipliers become higher.
This means that private consumption is mainly affected by disposable income.
22
The EFC Hypothesis describes a situation when the current decrease in government spending leads to an
increase in private consumption since the forward looking individuals anticipate decrease in future taxes - Giavazzi
and Pagano (1990). Similarly, increased taxes today to stabilize the current debt and the hence the avoidance of
future taxes can lead to an expansionary outcome raising the private consumption – Blanchard (1990), Bertola and
Drazen (1993).
23
The low debt case when debt was 25% of GDP and the case of high debt when debt was 85% of GDP.
24
This study will be the base for developing the second-empirical part of this master thesis.
21
13
distributed lag model in an error correction form. The long run relationship that they used
determined the private consumption as follows:
d
e
h
ci,t = αi + β1 yt,i
+ β2 wt,i
+ β3 wt,i
+ β4 g t,i + et,1
(5)
Where, i and t depict the country and time, c, y d w e , w h and g stand for the private consumption,
disposable household income, equity wealth, housing wealth and the government debt
respectively while e depicts the error term. All the variables are per capita, in real terms and
logarithms. After testing for stationarity and cointegration and found that all the variables were
I(1) with a cointegrating relationship they applied the pooled mean group estimator following
Pesaran, Shin and Smith (1999). Furthermore, the Berben & Brosens (2007) categorized the
countries into three groups25 taking into consideration the level of government debt as depicted
by debt to GDP ratio. According to their estimations the level of government debt was affecting
significantly and negatively the private consumption. From their estimations they draw the
conclusion that in low debt countries the government debt exerts no significant impact on private
consumption, while in the high debt countries the effect is significant and negative, undermining
the effectiveness of the fiscal policy. Berben and Brosens (2007) anticipated these outcomes
since in high debt countries individuals are more concerned about the “sustainability of
government debt”26.
Nickel & Vansteenkiste (2008), approached the validity of the Ricardian equivalence proposition
matter using an alternative methodology. Specifically, they investigated the relationship between
the fiscal balance and the current account for different levels of government debt27. To this end,
Nickel and Vansteenkiste applied a dynamic panel threshold model28 for 22 industrialized29
economies for the time period 1981-2005. As a first step using the likelihood ratio test they
determined three thresholds of government debt level30. The model’s estimations showed that in
low debt countries31, the relation between fiscal balance and current account was positive, still
positive but less robust in middle debt countries32 while negative though insignificant in high
debt countries33. This negative relationship between the fiscal and current deficit depicted that in
25
For an average debt to GDP ratio below 55% countries were considered low-debt countries, for a ratio above
75% the countries were characterized as high-debt countries, and the remaining countries were considered middle
debt countries.
26
And so they become more forward looking.
27
As defined by the various debt to GDP ratio levels.
28
The specification of the fixed effects threshold model was allowing the relationship between the fiscal balance
and the current account to change for different government debt levels.
29
Australia, Austria, Belgium, Germany, Canada, Denmark, Spain, Finland, France, UK, Greece, Ireland, Italy,
Iceland, Japan, Netherlands, Norway, New Zeeland, Portugal, Sweden, US and Taiwan.
30
The government debt thresholds were: 36%, 44% and 90%.
31
With debt to GDP ratio below 44%.
32
With debt to GDP ratio between 44% and 90%.
33
With debt to GDP ratio that exceeds the 90%.
14
high debt countries the consumers became Ricardian. This means that an increase in fiscal deficit
caused by an increase in government expenditures or a fall in taxes is not accompanied
necessarily by an increase in current deficit as the consumers increase their savings and reduce
their consumption. The results of Nickel and Vansteenkiste (2008) when they applied their
model exclusively for the eleven European economies of their initial sample, were similar to the
estimations derived for the overall sample. For the second sample of countries they found two
government debt thresholds34 and similar results regarding the relationship between fiscal and
current deficits. Most importantly when the government debt ratio exceeded the upper threshold
of 80% the relationship turned negative, an indication that the economy obtained Ricardian
characteristics.
Rohn (2010) tested the Ricardian equivalence hypothesis using a different alternative estimation
approach. Particularly, he studied the private savings offsets followed by an expansionary fiscal
policy based on an earlier study of de Mello, Kongsrud and Price (2004). Rohn, estimated an
autoregressive distributed lag (ARDL) model in an error correction form using data for 16
OECD countries for the period between 1970-2008. The estimation of the model was based on
the Mean Group (MG) estimator due to heterogeneity concerns following Pesaran and Smith
(1995). In order to broad his analysis Rohn incorporated also threshold effects for variables that
were connected with the Ricardian equivalence theorem such as: the government debt, liquidity
constraints and the distortionary taxation35. According to the estimation results, the saving offset
was approximately 40%, hence the “strict version” of the Ricardian equivalence proposition
could not be accepted36. The author additionally showed that the savings offset was stronger the
higher was the government debt and the more developed the financial market of a country was
suggesting less liquidity constraints. Specifically for the debt parameter, there was a full savings
offset when the government debt to GDP ratio exceeded the upper threshold of 76%. Similarly,
regarding the liquidity constraints, the offset was close to unity when the credit to GDP ratio
transcended the 62% threshold. The last findings constituted indication in favor of Ricardian
equivalence proposition. Rohn (2010) concluded that fiscal policy loses its effectiveness when
countries face high debt levels while obtains more robust effects during financial crisis when the
economy is credit constrained and the savings offset is lower.
Gogas et al. (2013) tested the validity of Ricardian equivalence hypothesis by investigating
directly the long run relationship between the government debt and the private consumption,
applying univariate time series and panel cointegration techniques for fifteen OECD countries
for the time period 1980-2010. Having tested for the existence of stochastic trends (unit roots)
and found that the time series were non stationary I(1) they proceeded on the cointegration
34
56% and 80%.
For the liquidity constraints the private credit to debt ratio was used , while for the distortionary taxation the
ratio direct to indirect taxes
36
In order for the strict version of the Ricardian equivalence proposition to be accepted we should have found “full
offset” which means 100% savings offset.
35
15
estimation37 applying the maximum likelihood cointegration test introduced by Johansen (1991)
in order to enforce the restrictions deriving from the Ricardian equivalence proposition theory.
According to the VAR estimations one cointegrating vector was detected for only two
countries38. Although, the restriction imposed by Ricardian Equivalence theory couldn’t be
rejected only for one of them39. The VECM that was performed for the case of United States
provided weak evidence in favor of the Ricardian Equivalence hypothesis. Regarding the panel
cointegration test, after testing for panel stationarity, the authors proceeded with the panel
cointegration test introduced by Pedroni (1999,2004). According to the panel cointegration test
results, the Ricardian Equivalence Hypothesis was rejected since there was not detected a
cointegrating relationship. According to the authors, the rejection of the Ricardian Equivalence
Hypothesis was attributed to matters related with intertemporal linkage and myopic consuming
behavior.
From the above analyzed studies we can initially conclude that the results regarding the validity
of Ricardian equivalence proposition are subject to the estimation approaches, the group of
countries and the time periods used each time. Despite the differences in the results of these
studies there is a common point in the majority of them implying that when government debt is
at unsustainably high levels, consumers start behaving in a Ricardian way.
5. Estimation Approaches
After the formulation of the Ricardian Equivalence theorem, various estimation approaches have
been suggested for testing the validity of this hypothesis. The proposed estimation methods
tested the Ricardian Equivalence proposition either directly investigating the impact of
government debt on private consumption or indirectly focusing on the validity of the implied
assumptions. The most widely used and hence accepted approaches are the following:
Private consumption function estimations:
The objective of this approach is to reveal the effect of government debt and other
macroeconomic variables on private consumption. According to Lucke (1998) the majority of
the consumption function studies converged in estimating the following consumption equation:
𝐶𝑡 = 𝛽0 + 𝛽1 𝑌𝑡 + 𝛽2 𝑊𝑡 + 𝛽3 𝐷𝑡 + 𝛽4 𝐺𝑡 + 𝛽5 𝑇𝑡 + 𝛽6 𝑆𝑆𝑡 + 𝛽7 𝑇𝑅𝑡 + 𝑒𝑟𝑟𝑜𝑟(6)
Where 𝐶𝑡 depicts the private consumption, 𝑌𝑡 the current income, 𝑊𝑡 the wealth of the
household, 𝐷𝑡 the public debt, 𝐺𝑡 the government expenditures, 𝑇𝑡 the tax revenues, 𝑆𝑆𝑡 the
social security claims and 𝑇𝑅𝑡 the transfers to households. The Ricardian Equivalence implies
that the government debt exerts no wealth effects on private consumption. Moreover, the
government expenditures affect negatively the consumption since lead to higher future taxes.
37
The existence of one casual relationship was necessary but not a sufficient condition for the validity of REP.
The United States and Mexico.
39
The United States.
38
16
The anticipation of future taxes makes the current generation reduce the current consumption and
instead increase its savings so as to make positive bequest to the next generation that will bear
the future tax burden. In addition since the government expenditures incorporate the effects of
tax revenues, social security contributions and transfers the impact of these variables should be
zero. Hence, Ricardian Equivalence imposes that: 𝛽2 > 0, 𝛽4 < 0, 𝛽3 = 𝛽5 = 𝛽6 = 𝛽7 = 0.
According with the Keynesian view, the public debt induces wealth effects on private
consumption and implies positive relationship between government expenditures and
consumption. Furthermore, the parameters that affect the household disposable income affect
accordingly the private consumption. To this end taxes and social security contributions decrease
the disposable income and hence consumption while the transfers increase the current income
and the private consumption consequently. According to the traditional view the anticipated
coefficients of the variables are: 𝛽2 > 0, 𝛽3 > 0, 𝛽4 > 0, 𝛽5 < 0, 𝛽6 < 0, 𝛽7 > 0.
Lucke (1998) stressed that this estimation approach suffers from the problem of simultaneity and
the possible existence of non stationary variables. According to Seater (1993), the variables that
the consumption functions incorporate are likely to be endogenous leading to the simultaneity
problem. This problem could be addressed with the introduction of instrumental variables. Lucke
noted that Feldstein (1982) used first instrumental variables and specifically lagged tax variables
to face the simultaneity problem. Referring to the second problem Lucke (1998) noticed that
when variables are non stationary, integrated of order one, the dependent variable should be
cointegrated with the independent variables in order the estimation to yield credible results.
Lucke (1998) furthermore mentioned that Kormendi (1983) addressed the specific problem
estimating the consumption function with the first difference approach rather than the levels.
Euler equation tests:
The next estimation approach is more theoretically grounded in the sense that is based on Euler
equations that derive from the permanent income life cycle hypothesis. Furthermore, the
consumption functions are obtained from the first order conditions of the consumer’s
maximization problem. The main purpose of the Euler equation tests is to investigate whether
individuals behave as infinitely lived. According to Lucke (1998), these tests were first
introduced by the Blanchard’s (1985) model of finite horizons. The finite horizons model of
Blanchard (1985) derived the following consumption function:
1−𝜇 𝑗
𝑑
𝐶𝑡 = 𝑎 [(1 + 𝑟)𝐴𝑡−1 + ∑∞
𝑗=0 ( 1+𝑟 ) 𝐸𝑡 𝑌𝑡+𝑗 ](7)
Where μ stands for the share of the population that dies each period, α is the propensity to
consume wealth, r is the constant rate of return on assets, 𝐴𝑡−1 are the assets the previous period
and 𝑌𝑡𝑑 is the real net labor income. The test of Ricardian Equivalence validity is hence equal to
estimating the parameter μ. If μ=0 the individuals live infinitely. This means that individuals will
be alive the time that the government will pay back the debt and hence they will adjust their
17
economic decisions accordingly not changing their current consumption. In this case Ricardian
Equivalence applies.
If μ≠0 a fraction of individuals will die before the government pays back the debt and with the
assumption that they do not concern about the survivors welfare they will increase their current
consumption invalidating the Ricardian Equivalence proposition. According to Lucke (1998)
Evans (1988) based on the Blanchard’s finite horizons model consumption function,
incorporating the aggregate budget constraint: 𝐴𝑡 = (1 + 𝑟)𝐴𝑡−1 + 𝑌𝑡𝑑 − 𝐶𝑡 derived the
following consumption function where 𝜀𝑡 stands for an expectational term.
1+𝑟
1+𝑟
𝐶𝑡 = (1−𝜇) (1 − 𝛼)𝐶𝑡−1 − 𝛼𝜇 1−𝜇 𝛢𝑡−1 + 𝛼𝜀𝑡 (8)
In the case of consumption function (2) if μ=0 the Ricardian Equivalence holds and the current
consumption 𝐶𝑡 depends exclusively on previous period consumption 𝐶𝑡−1 . Contrary, if μ≠0 the
neutrality hypothesis is not supported and the current consumption is determined by the previous
period consumption and amount of assets 𝛢𝑡−1 .
Interest rate approach:
The initial objective of this method it to reveal the relationship between the government debt and
the interest rate. The Ricardian Equivalence proposition implies that an increase in public debt
does leave the interest rate unaffected since it is not inducing wealth effects. On the contrary,
according to the traditional – Keynesian view, the raise in budget deficit exerts wealth effects
leading the current consumption the aggregate demand and the interest rate to increase. Lucke
(1998) following Plosser (1982) noted that for studying the real interest rate the vector
autoregressive model is more appropriate since can incorporate the effects of various exogenous
variables. Plosser (1982) investigated the effects of the government’s options to finance its
expenditures on asset prices40 and the interest rates and found that a debt increase did not affect
either the interest rate or the asset prices. Hence, he concluded in favor of the Ricardian
Equivalence proposition stating that the debt issue is not perceived as wealth by individuals who
avoid increasing their consumption. Evans (1988) stressed the suitability of the autoregressive
process in incorporating the nominal interest rates, the inflation and the exogenous variables.
Evans (1988) studied the effects of budget deficits on the interest rates and found no relationship
between them. Specifically, he used the following equation for the real interest rate:
40
U.S. Government securites
18
∞
∞
∞
∞
∞
𝑅𝑡 = ∑ 𝛼𝑟𝑖 𝑅𝑡−𝑖 + ∑ 𝛼𝑔𝑖 𝐺𝑡−𝑖 + ∑ 𝛼𝑑𝑖 𝐷𝑡−𝑖 + ∑ 𝛼𝑚𝑖 𝑀𝑡−𝑖 + ∑ 𝛼𝜋𝑖 𝛱𝑡−𝑖
𝑖=1
∞
𝑖=0
𝑖=0
∞
𝑖=0
∞
𝑖=0
∞
+ ∑ 𝑎𝑧𝑖́ 𝑍𝑡−𝑖 + ∑ 𝑏𝑔𝑖 𝐸𝑡 𝐺𝑡+𝑖 + ∑ 𝑏𝑑𝑖 𝐸𝑡 𝐷𝑡+𝑖 + ∑ 𝑏𝑚𝑖 𝐸𝑡 𝑀𝑡+𝑖
𝑖=𝜊
∞
𝑖=1
∞
𝑖=1
𝑖=1
+ ∑ 𝑏𝜋𝑖 𝛦𝑡 𝛱𝑡+𝑖 + ∑ 𝑏́𝑧𝑖 𝐸𝑡 𝑍𝑡+𝑖 (9)
𝑖=1
𝑖=1
Where 𝑅𝑡 stands for the real interest rate, 𝐺𝑡 for real the government expenditures, 𝐷𝑡 and 𝑀𝑡 for
the real budget deficit and the money supply respectively and 𝛱𝑡 for the inflation rate. Ricardian
Equivalence entails that budget deficits exert no impact on real interest rate. Hence adi should be
equal to zero.
On the contrary, according to the traditional theory the relationship between the budget deficits
and the real interest rate is positive (adi >0). In addition, the previous period government
expenditures tend to increase the interest rate while the money supply exerts the opposite effect.
The logic behind the relationship between that budget deficit and the interest rate is that a larger
past budget deficit leads to a larger public debt. Since individuals perceive government debt as
net wealth they increase the private consumption and money demand. Hence, the real interest
rate increase to mitigate the excess demand.
Exchange rate approach:
Since the interest rate in open economies can be affected by other factors than the budget deficit
some studies have focused on the effects of budget deficits on the exchange rates. According to
Beck (1994) the capital mobility transfers the effect of budget deficits from the interest rate to
the exchange rate. The reasoning behind this argument is that due to capital mobility the interest
rate parity holds. Hence, the interest rate remains stable and any effects from the budget deficits
are transmitted at the exchange rates. According to Beck (1994) the Ricardian Equivalence
proposition implies that the budget deficits yield no impact on the exchange rates while the
conventional view entails that the budget deficits cause appreciation of the domestic currency
and accordingly decrease of the exchange rate. Beck (1994) in order to test the validity of the
Ricardian Equivalence hypothesis estimated the following equations regarding the changes in
exchange rate41:
𝑠𝑖𝑡 − 𝑠𝑖𝑡𝑒 = 𝛼0 + 𝛼1 (𝜇𝑡 − 𝜇𝑡 𝑒 ) + 𝑎2 (𝜋𝑡 − 𝜋𝑡𝑒 ) + 𝛼3 (𝑏𝑡 − 𝑏𝑡𝑒 ) + 𝛼4 (𝑔𝑡 − 𝑔𝑡𝑒 ) (10)
𝑒
𝑒
𝑠𝑖𝑡 − 𝑠𝑖𝑡−1 = 𝑐0 + 𝑐1 𝜋𝑡 + 𝑐2 (𝜇𝑡 − 𝜇𝑡−1 ) + 𝑐3 (𝜋𝑡+1
− 𝜋𝑡𝑒 ) + 𝑐4 [𝑏𝑡+1
− 𝑏𝑡𝑒 ]
𝑒
+ 𝑐5 [𝑔𝑡+1
− 𝑔𝑡𝑒 ] (11)
41
Price of currency i in terms of the domestic currency.
19
Where 𝑠𝑖𝑡 depicts the price of currency i in terms of the domestic currency, 𝑠𝑖𝑡 𝑒 the expected
value of currency i, while 𝜇𝑡 and 𝜇𝑡 𝑒 illustrate the money growth rate and the projection of
money growth rate respectively. In addition, 𝜋𝑡 stands for the inflation rate, 𝑏𝑡 for the budget
surplus or deficit, and 𝑔𝑡 for the government expenditures. The effect of the money growth and
inflation is positive in any case. The money growth leads to domestic currency depreciation
either caused by a decrease of real interest rate due to the increased money supply or the raise of
the nominal interest rates due to the rise of expected inflation. Inflation coefficients are positive
for reasons relating to the decreased domestic currency’s purchasing power relative to the
foreign currencies. Hence:𝑎2 , 𝑐1, 𝑐3 , 𝛼1 , 𝑐2 >0. According to the traditional economic theory the
government deficits lead to domestic currency appreciation and hence the exchange rate to
decrease. This implies that the corresponding coefficients of the government deficit variables are
positive: 𝛼3 , 𝑐4 >0. On the contrary for the Ricardian Equivalence to hold the budget deficit
variables should exert no impact on the exchange rate which means that the corresponding
coefficients 𝛼3 and 𝑐4 should be equal to zero.
Public/Private Savings offset approach:
Apart from the approaches that test the validity of the neutrality hypothesis investigating the
direct effects of government debt there are studies that examine the Ricardian Equivalence
proposition indirectly, focusing on the interaction of the affected components.
The reasoning behind the public/private savings offset approach is that decreases in public
savings due to fiscal policy changes will be offset by the Ricardian individuals that they will
adjust their behavior accordingly leaving the national savings fixed. Specifically, in case of
deficit financed tax cuts or government expenditures the public savings decrease. On the other
side the forward looking farsighted individuals that anticipate future tax increases for the deficit
to be paid back will decrease their current consumption and increase their savings accordingly.
As a result the increase in private savings offsets the decrease in public savings leaving the
national savings unchanged. Hence, the Ricardian Equivalence proposition hold. In addition the
strict version of the Ricardian proposition implies full offset between public and private savings.
De Mello et al. (2004) investigated the private and public savings offset for 21 OECD countries
for the period 1970-2002. The authors used an error correction framework to describe the
relationship between the private and public savings:
𝑆𝑖𝑡𝑝𝑟𝑖𝑣 = 𝛼0 + 𝛼1 𝑆𝑖𝑡𝑝𝑢𝑏 + 𝑎2 𝑋𝑖𝑡 + 𝑒𝑖𝑡 (12) and
𝑝𝑟𝑖𝑣
𝛥𝑆𝑖𝑡𝑝𝑟𝑖𝑣 = 𝛽0 + 𝛽1 𝛥𝑆𝑖,𝑡−1
+ 𝛽2 𝑒𝑖,𝑡−1 + 𝛽3 𝛥𝑆𝑖𝑡𝑝𝑢𝑏 + 𝛽4 𝛥𝑋𝑖𝑡 + 𝑣𝑖𝑡 where 𝛽2 < 0 (13)
From (6) and (7) they estimated the following equation:
𝑝𝑟𝑖𝑣
𝑝𝑟𝑖𝑣
𝑝𝑢𝑏
𝛥𝑆𝑖𝑡𝑝𝑟𝑖𝑣 = (𝛽0 − 𝛽2 𝛼0 ) + 𝛽1 𝛥𝑆𝑖,𝑡−1
+ 𝛽2 𝑆𝑖,𝑡−1
+ 𝛽3 𝛥𝑆𝑖𝑡𝑝𝑢𝑏 − 𝛽2 𝛼1 𝑆𝑖,𝑡−1
+ 𝛽4 𝛥𝑋𝑖𝑡 − 𝛽2 𝛼2 𝑋𝑖,𝑡−1
+ 𝑣𝑖𝑡 (14)
20
𝑝𝑟𝑖𝑣
𝑝𝑢𝑏
Where 𝑆𝑖𝑡 and 𝑆𝑖𝑡 stands for the private and public savings ratio, 𝑋𝑖𝑡 for the vector of control
variables, e and v for the error terms while i and t depicts the country and time respectively.
According to De Mello Kongsrud and Price (2004) previous studies that investigated the subject
of public and private savings offset estimated the following equation:
𝑝𝑟𝑖𝑣
𝑆𝑖𝑡𝑝𝑟𝑖𝑣 = 𝛾0 + 𝛾1 𝑆𝑖,𝑡−1
+ 𝛾2 𝑆𝑖𝑡𝑝𝑢𝑏 + 𝛾3 𝑋𝑖𝑡 + 𝑢𝑖𝑡 (15)
The strict version of Ricardian Equivalence proposition implies full offset of the private savings.
In the case of equation (8) this implies that the coefficient of public savings variable should be
equal with minus one (𝛾2 = −1).
The twin deficits method:
The objective of this approach is to reveal the sign of the relationship within the fiscal deficits
and the current account deficits. The twin deficits hypothesis which is in line with the Keynesian
macroeconomic theory implies that increments in fiscal deficits lead to current account deficit
increases. The logic behind this argument is that in case of fiscal deficit42 consumers react by
increasing their current consumption as they perceive the deficit increase as net wealth
decreasing their savings accordingly. As a result the national savings fall and the current account
deficit increases. Hence according to the Keynesian view the relationship between the budget
deficit and the current account deficit is positive.
On the contrary, the Ricardian Equivalence proposition entails that consumers do not realize the
deficit increase as net wealth and hence do not increase their current consumption. Instead
individuals raise their savings and decrease their consumption accordingly in order to be able to
pay the future taxes that the increased budget deficit implies. In this case the reduced public
savings following the expansionary fiscal policy can be offset or even overcompensated by the
increased private savings Nickel & Vansteenkiste (2008). Consequently, the Ricardian
hypothesis implies a stable or a negative relationship between the budget and the current account
deficit. According to Nickel & Vansteenkiste (2008) the stable or even negative relationship
between budget and current account deficit is also present in the case of fiscal consolidation43. In
the case of an excessively high debt, a fiscal consolidation policy affects the individuals
expectations leading them to increase their current consumption and diminish their savings in
anticipation of fewer future taxes and more prosperous future conditions. As a result the
increased national savings are offset or even transcended by the decreased private savings
leading to a stable or even negative relationship between fiscal and current account deficit.
Nickel & Vansteenkiste (2008) studied the relationship within the fiscal and current account
deficits taking into consideration the government debt44 estimating a panel threshold model for
42
That could take the form of deficit financed tax cuts or increases in government expenditures.
Fiscal consolidation programs are implemented by the governments with the objective to restrict the Fiscal
deficit.
44
Expressed by the ratio government debt to GDP.
43
21
22 industrialized countries. According to their findings, the relationship between the fiscal and
current account deficit was positive for the low in debt countries and positive but less potent for
the moderate and high indebted countries revealing the existence of Keynesian characteristic
within the consumers. In contrast the authors revealed a negative but insignificant relationship
within the two deficits in the very indebted countries pointing that these countries obtained
Ricardian characteristics.
6. Data Analysis – A part
In order to begin our analysis we will classify the main European economies into two groups.
The classification is based on the importance of the economies and the noteworthy level of
government debt. Specifically, we will categorize ten European countries into two groups. The
first group contains the less indebted countries such as Luxemburg, Finland, Netherlands,
Germany and Austria, while the second group includes the countries with considerably high level
of government debt such as France, Belgium, Ireland, Portugal and Italy. In the graphs below we
can observe how the government debt evolves as it is described by the debt to GDP ratio45 for the
above mentioned countries:
Graph 1 – Debt level for 2013
Countries
Graph 1 - Debt to GDP ratio / 2013
Luxemburg
Finland
Netherlands
Germany
Austria
France
Belgium
Ireland
Italy
Portugal
Debt to GDP ratio
0
50
100
150
Debt to GDP ratio
Data taken from the IMF database
45
Data taken from the IMF Database.
22
In the graphs below we can interestingly notice the evolution of public debt for the ten countries
used in our study. Graphs from 2-11 – Debt to GDP ratio per country
60
40
20
0
2000
2002
2004
2006
2008
2010
2012
Debt to GDP
ratio for
Luxemburg
Graph 3 - Debt to GDP ratio /
Finland
Debt to GDP ratio
Years
Graph 5 - Debt to GDP ratio /
Germany
Debt to GDP
ratio for
Netherlands
40
Debt to GDP
ratio for
Germany
20
0
2000
0
60
Years
2012
40
80
2009
60
100
2006
80
Debt to GDP ratio
Debt to GDP ratio
Graph 4 - Debt to GDP ratio /
Netherlands
20
Debt to GDP
ratio for
Finland
Years
2003
25
20
15
10
5
0
2000
2002
2004
2006
2008
2010
2012
Debt to GDP ratio
Graph 2 - Debt to GDP ratio /
Luxemburg
Years
23
100
80
60
Debt to GDP
ratio for
Austria
60
40
Debt to
GDP ratio
for France
20
0
Years
Years
Graph 9 - Debt to GDP ratio /
Ireland
Debt to
GDP ratio
for Ireland
2000
Debt to GDP
ratio for
Belgium
140
120
100
80
60
40
20
0
Years
Years
Debt to GDP ratio
Debt to GDP
ratio for Italy
Graph 11 - Debt to GDP ratio
/ Portugal
140
120
100
80
60
40
20
0
Debt to
GDP ratio
for
Portugal
2000
2002
2004
2006
2008
2010
2012
Debt to GDP ratio
Graph 10 - Debt to GDP ratio /
Italy
140
120
100
80
60
40
20
0
2003
120
100
80
60
40
20
0
Debt to GDP ratio
Debt to GDP ratio
Graph 8 - Debt to GDP ratio /
Belgium
2012
0
80
2009
20
100
2006
40
Graph 7 - Debt to GDP ratio /
France
Debt to GDP ratio
Debt to GDP ratio
Graph 6 - Debt to GDP ratio /
Austria
Years
Years
Data taken from IMF database
24
Comments on the graphs: Luxemburg although had particularly low public debt level (debt to
GDP ratio around 7) till 2007 its debt increased sharply almost quadrupled the next five years. In
Finland the debt had a decreasing pattern till 2008 and a considerable opposite trend the years
after. The same pattern seems to hold also for the Netherlands that its debt level was almost
constant till 2005, decreasing for the next two years till 2007 and increasing afterwards.
Considering the case of Germany its debt is steadily increasing till 2006 follows an opposite
pattern the period within 2006-2008 while increases till 2010 and decreases afterwards. The debt
to GDP ratio in Austria is almost steady till 2007, increases till 2010 and experiences a
diminishing trend afterwards. Regarding the public debt for the French economy we can notice
interestingly that it is characterized by a constant increasing trend the whole period under
examination with only exception a slight decrease during the period 2005-2007. Furthermore, the
Belgian economy is being characterized by a diminishing debt to GDP ratio till 2006 and an
opposite trend afterwards. The development of the Irish public debt level is especially
remarkable. As we can observe the public debt that was decreasing till 2007 experienced an
explosive increase the years after. Specifically, the debt to GDP ratio raised from 24 the year
2007 to 123,3 the year 2013. The Italian government debt while considerably high was almost
constant till 2008 obtaining a raising trend afterwards. Lastly the Portuguese economy
experiences a constant and considerable increasing trend in the debt to GDP ratio. The
corresponding ratio was 48 on 2000 and 130 on 2013.
From the above analysis we can observe that the low debt countries experienced a considerable
increase at their debt level after 2007 with the outburst of the economic crisis. On the contrary,
the more indebted countries that their economies were being characterized by a constantly
increasing trend in their debt level or by already excessively high debt levels experienced
derailment of their debt after the outbreak of the crisis.
Before conducting the main analysis testing the validity of Ricardian Equivalence estimating the
private consumption function we will first try to detect any possible indication of validity
investigating the gross public and private savings both graphically and quantitatively.
Graphical Approach:
The objective of this method is to reveal any offsetting trends – negative relationship between
the gross public and private savings implying possible validity of the Ricardian Equivalence
Hypothesis. The logic behind this argument is that according to the Ricardian view the decrease
in public savings derived from a deficit financed tax cut or government expenditures increase
will be accompanied by a raise in private savings since the consumers are concerned about the
future tax liabilities that these policies will induce. In order to continue with this analysis we will
simultaneously observe the evolution of gross public and private savings for each country for the
period within 1995 and 2014 both in levels and in first difference approach. We can clearly
notice that the offsetting trends are more easily detected from the graphs 22-31 that illustrate the
Gross Public and Private savings in first difference. Data on Gross Public, Private and National
25
savings were extracted from the European Commission, Economic and Financial Affairs
database.
Graphs 12-21 Gross Public and Private Savings for each country
Years
50
0
-50
Years
Gross
Private
Savings
2013
2010
2007
2004
Gross
Private
Savings
Graph 15 - Gross Public &
Private Savings / Germany
Savings in Billions
Gross
Public
Savings
1995
1998
2001
2004
2007
2010
2013
Savings in Billions
200
100
2001
Years
Graph 14 - Gross Public &
Private Savings / Netherlands
150
1998
Gross
Public
Savings
1995
Gross
Private
Savings
50
40
30
20
10
0
800
600
Gross
Public
Savings
400
200
0
-200
1995
1998
2001
2004
2007
2010
2013
2013
2010
2007
2004
2001
1998
Gross
Public
Savings
Graph 13 - Gross Public &
Private Savings / Finland
Savings in Billions
10
8
6
4
2
0
1995
Savings in Billions
Graph 12 Gross Public &
Private Savings / Luxemburg
Gross
Private
Savings
Years
26
Graph 17 - Gross Public &
Private Savings / France
200
2011
20
0
-20
Gross
Private
Savings
Years
Graph 21 - Gross Public &
Private Savings / Italy
400
Gross
Private
Savings
100
0
-100
Years
2011
Years
2011
2007
2003
1999
1995
0
2007
10
Gross Public
Savings
200
2003
20
300
1999
Gross Public
Savings
1995
30
Savings in Billions
40
Savings in Billions
Gross Public
Savings
40
1995
1998
2001
2004
2007
2010
2013
Gross
Private
Savings
Savings in Billions
2011
2007
2003
Gross Public
Savings
Graph 20 - Gross Public and
Private Savings / Portugal
-20
Years
Graph 19 - Gross Public &
Private Savings / Ireland
Years
-10
Gross
Private
Savings
60
1999
120
100
80
60
40
20
0
-20
1995
Savings in Billions
Graph 18 - Gross Public &
Private Savings / Belgium
2007
-200
Years
2003
0
1999
Gross
Private
Savings
Gross Public
Savings
400
1995
2011
2007
2003
Gross Public
Savings
Savings in Billions
600
1999
100
80
60
40
20
0
-20
1995
Savings in Billions
Graph 16 - Gross Public and
Private Savings / Austria
Gross
Private
Savings
27
Graphs 22-31 Gross Public and Private Savings in first Difference for each country
-2
Years
2014
2011
Δ Gross
Private
Savings
50
2014
2011
2008
2005
2002
-50
1999
0
-100
Years
Δ Gross
Public
Savings
Years
Graph 27 - Gross Public &
Private Savings in Differences /
France
Years
Δ Gross
Public
Savings
2014
2011
Δ Gross
Private
Savings
Δ Gross
Public
Savings
-40
-60
-80
2008
-20
2005
0
2002
2014
2011
2008
2005
2002
1999
0
20
1999
Δ Gross
Private
Savings
1996
5
Difference in Billions
40
1996
Difference in Billions
Years
1996
Δ Gross
Public
Savings
Difference in Billions
2014
2011
2008
2005
2002
1999
1996
Difference in Billions
Δ Gross
Private
Savings
10
-10
-15
Δ Gross
Public
Savings
100
Graph 26 - Gross public &
Private Savings in differences /
Austria
-5
-10
Δ Gross
Private
Savings
Graph 25 - Gross Public &
Private Savings in differences /
Germany
Graph 24 - Gross Public &
Private Savings in Differences
/ Netherlands
30
20
10
0
-10
-20
-30
-40
-5
2008
Δ Gross
Public
Savings
2005
2014
2011
2008
2005
2002
-1
1999
0
0
2002
1
5
1999
Δ Gross
Private
Savings
10
1996
2
Graph 23 - Gross Public &
Private Savings in Differences /
Finland
Difference in Billions
3
1996
Difference in Billions
Graph 22 - Gross Public &
Private Savings in differences
/ Luxemburg
Years
28
Graph 28 - Gross Public &
Private Savings in Differences
/ Belgium
10
5
2014
2011
2008
2005
2002
-5
1999
0
-10
-15
Δ Gross
Private
Savings
5
Δ Gross
Public
Savings
-5
Years
0
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
10
1996
Difference in Billions
15
Graph 29 - Gross public &
Private Savings in Differences
/ Ireland
-10
Δ Gross
Private
Savings
Δ Gross
Public
Ireland
-15
Graph 30 - Gross Public &
Private Savings in Differences
/ Portugal
Graph 31- Gross public &
Private Savings in Differences
/ Italy
-10
Years
2014
2011
2008
2005
2002
-5
1999
Δ Gross
public
Savings
-40
-60
2014
2011
2008
2005
-20
2002
0
1999
0
20
1996
Δ Gross
Private
Savings
5
1996
Difference in Billions
10
Difference in Billions
40
Δ Gross
Private
Savings
Δ Gross
Public
Savings
Years
From the graphs above we observe that the offsetting trend – the negative relationship between
the gross public and private savings is more obvious in some countries and less potent in the rest
economies in our sample. Specifically, we notice that the offsetting relationship is more clear for
the countries of Netherlands Germany and Austria regarding the low debt group of countries and
for all the more indebted countries in our sample. In addition we notice that this negative
relationship becomes more apparent after the outbreak of the economic crisis of 2007 leading us
to the primary conclusion that in these countries consumers may have become more concerned
about the government debt sustainability, consequently more forward looking and hence have
adjusted their behavior accordingly.
29
Quantitative Approach:
Ricardian equivalence proposition implies a negative-offsetting relationship between the public
and the private savings. Furthermore, the strict version of the Ricardian hypothesis entails that
the public and private savings become perfect substitutes and hence the national savings stable
and stationary. Furthermore, the stationarity of national savings means that the public and private
savings should be cointegrated, which also implies that the both types of savings need to be I(1).
For this specific part of the analysis we followed Castro & Fernandez (2009) 46 that tested the
validity of the Ricardian hypothesis implementing three different approaches for the country of
Spain. Due to data availability problems we used in our analysis the national savings expressed
in billions instead of the total national savings as a percentage of GDP.
According to the results, the stationarity of national savings was not supported for all the
countries in the sample since we could not reject the null hypothesis of non stationarity with the
conventional levels of statistical significance. Hence, these initial findings are against the
Ricardian Equivalence proposition. In the appendix (tables 1-10) we can observe the results of
the Augmented Dickey Fuller – Unit root tests for all the countries under examination. In order
to proceed with our analysis we performed stationarity ADF-tests both for the public and private
savings for all the countries and when detecting non stationarity I(1) for the both types of savings
we proceeded with Johansen cointegration tests in order to check the existence of possible
cointegration relationships between the both types of savings. According to the results, the two
types of savings were jointly non stationary I(1) for the countries of Finland, Netherlands,
Germany and Portugal. Though, the Johansen cointegration tests (tables 11-14 in the Appendix)
revealed one cointegrating equation for the countries of Finland, Netherlands and Germany and
no cointegration relationship for the country of Portugal. These primary findings are in favor of
the Ricardian proposition. The cointegration results were expected especially for the countries of
Netherlands and Germany since we had already noticed the offsetting pattern of public and
private savings for these countries at the graphical approach. Additionally since the stationarity
of national savings is a necessary but not sufficient condition for the Ricardian equivalence to
hold we proceeded with the main quantitative analysis estimating the private consumption
function.
7. Main Estimation Analysis
The objective of our main data analysis is to test the validity of the Ricardian Equivalence
Hypothesis for different levels of government debt. To this end we will estimate the effect of
government debt on private consumption and see how this relationship changes for different
levels of government debt. Hence, we will investigate the impact of public debt on the two
groups of countries, the high and low debt groups of countries following the initial classification
in our sample. The most appropriate consumption function that allows us to test the impact of
46
“The relationship between public and private savings in Spain: Does Ricardian Equivalence hold?”
30
government debt on private consumption and hence the Ricardian proposition for different debt
levels is the long run consumption function developed by Berben & Brosens (2007) as follows:
d
e
h
ci,t = αi + β1 yt,i
+ β2 wt,i
+ β3 wt,i
+ β4 d + εt,i , i = 1,2, … , N, t = 1,2, … , T(16)
Where c denotes the private consumption, y d the household disposable income, w e the equity
wealth, w h the housing wealth, d the government debt and finally ε stands for the error term.
Later we will incorporate in the initial consumption function the government expenditures
variable g.
As a first step we estimated the private consumption function for each country in our sample
individually. Then we proceeded with the panel data analysis for three groups of countries47
allowing us to investigate the impact of government debt for the high and low indebted countries.
Finally, we incorporated equation (16) in an autoregressive distributed lag (ADRL) model in an
error correction framework in order to investigate the short run dynamics.
Data:
Our analysis covers 9 European countries48 four low debt (Finland, Netherlands, Austria and
Germany) and five high government debt countries (France, Belgium, Ireland, Italy and
Portugal) for the period 1993-2013. The data are in annual frequency and all the variables are in
logarithms, per capita and in real terms. Following Berber & Brosens (2007) we used stock
market and housing prices as proxies for the equity and housing wealth variables respectively.
For the private consumption we used the private final consumption expenditures of households,
for the household disposable income the real net household disposable income deflated by the
final consumption deflator, while for the government debt we used the Maastricht - general
government gross debt. In addition, for the government expenditures we used the general
government final consumption expenditures49. The data regarding the private consumption, the
disposable income, the government debt, the government expenditures, the population and the
private final consumption deflator50 were taken from the OECD database. The data for the stock
price and the house price indexes were extracted from the Thomson Financial and the Bank of
International Settlements database.
Research questions:
The aim of this analysis is to investigate the relationship between the government debt and the
private consumption in order to examine the validity of the Ricardian Equivalence and to
consider how this relationship changes for different levels of public debt e.g. for high and low
debt countries. Specifically, we expect to find that in low debt countries government debt exerts
no or a slight positive impact on private consumption. On the contrary, in high debt countries the
47
All the countries in the sample, the high debt and the low debt countries.
We excluded the country of Luxemburg due to data availability problems.
49
We will incorporate later in our analysis the Government expenditures parameter.
50
In order to convert our variables in real terms and per capita.
48
31
impact of government debt on private consumption could be negative as individuals being more
concerned about the public debt sustainability become more forward looking and realize that the
current debt issue will provoke the need for future taxes in order the debt to be paid back. Hence
they don’t consider the debt as net wealth leaving their consumption constant (or even decrease
it). The anticipated results above are in line with the main findings of Berben and Brosens
(2007). According to the conventional economic theory the public debt is perceived as net wealth
by the individuals and consequently affects positively the private consumption. On the contrary,
according to the Ricardian Equivalence perspective the government debt exerts no wealth effects
and hence leaves the private consumption unaffected. To this end, according to the conventional
economic theory the public debt coefficient will be positive (β4>0) while zero in the Ricardian
case (β4=0). Regarding the government expenditures according to the Keynesian view the impact
of the government expenditures on private consumption will be positive implying a positive
coefficient (β5>0) while negative according to the Ricardian proposition (β5<0). The Ricardian
logic implies that the increase in government expenditures will cause the need for future taxes
making the forward looking – farsighted consumers adjust their behavior accordingly decreasing
their current consumption. The coefficients of disposable income, equity and housing wealth
should be positive in both cases due to their positive relationship with the private consumption
(β1, β2, β3>0). Our enriched consumption function that incorporates the government expenditures
variable is as follows:
d
e
h
ci,t = αi + β1 yt,i
+ β2 wt,i
+ β3 wt,i
+ β4 d + 𝛽5 g + εt,i , i = 1,2, … , N, t = 1,2, … , T(17)
In the tables below we can see our individual estimations for each country, for both the basic and
the extended consumption function (including also the government expenditures variable) first in
Levels and the in first differences.
Table 15 – Estimations of the basic consumption function (16)
Individual Estimations Basic Equation
Countries
Yd
we
wh
d
Austria
0.2978
0.0201
-0.1372*** 0.3460***
(0.2410)
(0.0180)
(0.0355)
(0.0695)
Finland
0.7212***
0.0089
0.1904
0.0197
(0.2395)
(0.0148)
(0.1608)
(0.0435)
Low Debt
Netherlands 0.4553*** 0.0378*** 0.2019*** 0.0430**
(0.1113)
(0.0068)
(0.0219)
(0.0157)
Germany
0.9342*** 0.0204***
0.0450
0.0452***
(0.0708)
(0.0042)
(0.0627)
(0.0146)
***
***
***
France
0.7033
0.0206
0.0598
0.0197**
(0.0454)
(0.0041)
(0.0082)
(0.0084)
Belgium
0.8541***
0.0506***
0.0931*** 0.2061**
(0.1841)
(0.0124)
(0.0289)
(0.0737)
High Debt
Ireland
0.6602** 0.0924***
0.1713
0.0249
(0.2273)
(0.0253)
(0.1046)
(0.0365)
Italy
0.3079
0.0902*** 0.2439*** 0.3544*
(0.2511)
(0.0187)
(0.0534)
(0.1920)
32
Portugal
0.9764***
(0.1389)
0.0095
(0.0161)
0.0266
(0.1046)
0.0492
(0.0442)
Notation ***,** and * denotes the 1%, 5% and 10% level of statistical significance.
Table 16 – Estimations of the Extended consumption function (17) including the government
expenditures variable
Individual Estimations Extended Equation (including g)
Countries
Yd
we
wh
d
Austria
0.1493
0.0151
-0.1141***
0.2081
(0.2581)
(0.0179)
(0.0384)
(0.1207)
Finland
-0.0788
0.0239**
0.1482
-0.0067
(0.2392)
(0.0105)
(0.1085)
(0.0298)
Low Debt
Netherlands 0.3646*** 0.0278*** 0.2825*** 0.1020***
(0.0995)
(0.0068)
(0.0347)
(0.0252)
***
Germany
0.9032
0.0206***
-0.0212
0.0205
(0.0716)
(0.0041)
(0.0755)
(0.0220)
France
0.7308*** 0.0197*** 0.0626***
0.0262
(0.0760)
(0.0046)
(0.0104)
(0.0167)
Belgium
0.5323*** 0.0494*** -0.1181***
0.0576
(0.1125)
(0.0046)
(0.0372)
(0.0465)
Ireland
0.0080
0.0528***
0.0979
0.0025
High Debt
(0.1820)
(0.0168)
(0.0643)
(0.0223)
Italy
-0.1071
0.0501***
-0.0336
-0.1555
(0.1630)
(0.0129)
(0.0577)
(0.1430)
Portugal
0.6940**
0.0161
-0.0368
0.0248
(0.2672)
(0.0167)
(0.1152)
(0.0479)
g
0.3238
(0.2349)
0.7053***
(0.1560)
-0.1005**
(0.0366)
0.0877
(0.0597)
-0.0499
(0.1088)
0.4570***
(0.0730)
0.3920***
(0.0724)
0.5131***
(0.0901)
0.1626
(0.1321)
Notation ***,** and * denotes the 1%, 5% and 10% level of statistical significance.
From the table 15 we can observe that Ricardian Equivalence is rejected for the majority of the
countries since the government debt coefficient is positive for each country and in most cases
statistical significant. The above mentioned results become less potent regarding the rejection of
the Ricardian Equivalence Hypothesis when we estimate the extended consumption function
(incorporating the government expenditures) table 16. Specifically, we notice that the debt
coefficients although positive become less potent and statistically insignificant. In only two
cases51the debt coefficients were negative pointing that individuals obtained ricardian
characteristics in these countries, but the debt coefficients were not statistical significant while
the government expenditure coefficients were positive and statistical significant in favor of the
Keynesian proposition. From the results in first differences (tables 17) we notice the presence of
Ricardian characteristics in one low debt country (Finland) and for the majority of the high debt
countries (Belgium, Ireland, Italy and Portugal) since the debt coefficients are negative though
statistical insignificant. Furthermore, when we incorporate in our analysis the government
expenditures (table 18) the corresponding government expenditure coefficients do not have the
51
In case of Finland and Italy.
33
expected negative sign for these countries. The only exception is the country of Portugal where
both coefficients are negative but not statistically significant. Moreover, regarding the
coefficients of disposable income, equity and housing wealth all have the expected signs and are
statistically significant with few only exceptions.
Before proceeding with our panel estimation approach we first examined our time series for
stationarity and cointegration. Following Berben and Brosens (2007) we tested for stationarity
using the Im, Pesaran & Shin and ADF - Fisher Chi – Square tests and for cointegration applying
the Group ADF test. Our results are in accordance with Berben and Brosens as we found that that
all the variables are non stationary I(1) (tables 19 and 20) and cointegrated (tables 21 and 22).
Especially for the cointegration test we revealed that the cointegration is less potent when we
exclude the private consumption variable from the cointegration test. This also holds true in the
case that we incorporate the government expenditure variable in our analysis. In the tables below
we can observe the results from the stationarity and cointegration tests for both cases.
Table 19 – Panel unit root tests for the basic equation
Panel Unit Root Estimates / Basic Equation
Tests
Variables
Im, Pesaran & Shin W-Stat. ADF – Fisher Chi-Square
Consumption / c
4.4946
3.0907
d
Disposable Income / Y
5.1915
2.0660
Stock Price / we
-1.6876**
26.2938*
House Price / wh
-0.2446
20.4339
Government Debt / d
1.8824
7.4729
Notation ***,** and * denotes 1%, 5% and 10% level of statistical significance.
Table 20 – Panel unit root tests for the extended equation including also the government
expenditures variable
Panel Unit Root Estimates / Extended Equation (including g)
Test
Variables
Im, Pesaran & Shin W-Stat. ADF – Fisher Chi-Square
Consumption / c
4.4946
3.0907
d
Disposable Income / Y
5.1915
2.0660
Stock Price / we
-1.6876**
26.2938*
House Price / wh
-0.2446
20.4339
Government Debt / d
1.8824
7.4729
Government Expenditures / g
3.6068
4.7517
Notation ***,** and * denotes 1%, 5% and 10% level of statistical significance.
Table 21- Panel Cointegration – Group ADF test – for the basic equation
Panel Cointegration - Group ADF test - Basic Equation
34
Variables
Private Consumption / c
Disposable Income / yd
-1.5956*
Stock Price / we
House Price / wh
Government Debt / d
Excluding Private Consumption variable
Variables
Disposable Income / yd
Stock Price / we
-0.9611
House Price / wh
Government debt / d
Notation ***,** and * denotes 1%, 5% and 10% level of statistical significance.
Table 22- Panel Cointegration – Group ADF test – for the extended equation including also the
government expenditures variable
Panel Cointegration - Group ADF test - Extended Equation (including
g)
Variables
Private Consumption / c
Disposable Income / yd
Stock Price / we
-3.7068***
House Price / wh
Government Debt / d
Government Expenditures / g
Excluding Private Consumption variable
Variables
Disposable Income / yd
Stock Price / we
-2.1241**
House Price / wh
Government Debt / d
Government Expenditures / g
Notation ***,** and * denotes 1%, 5% and 10% level of statistical significance.
We will proceed in our main analysis estimating both the basic and the extended consumption
function in a panel data framework for three groups of countries52 in order to study the long run
effects of the explanatory variables on private consumption. This approach allows us to
investigate the long run effects and more interestingly the impact of government debt on private
consumption for different levels of debt. In the tables 23 and 24 below we can observe the results
52
All the countries, the Low debt and the High debt countries groups.
35
obtained from the estimations of both the basic equation and the extended consumption function
which incorporates the government expenditure variable.
Table 24 – Panel Estimations of the basic equation
Panel Estimation Basic Equation
Countries Classification
Yd
we
Wh
d
***
***
All countries
0.8304
0.0131
0.0776*** 0.0154**
(0.0166) (0.0017) (0.0082) (0.0080)
Low Debt Countries
0.8072*** 0.0148*** 0.1255*** 0.0709***
(0.0271) (0.0026) (0.0068) (0.0145)
High Debt countries
0.7911*** 0.0133*** 0.0710*** 0.0267**
(0.0333) (0.0026) (0.0195) (0.0134)
Notation ***,** and * denotes 1%, 5% and 10% level of statistical significance. The values in the parentheses depict standard
errors.
Table 25 – Panel Estimations of the extended equation
Panel Estimation Extended Equation (including g)
Countries Classification
Yd
we
Wh
d
g
***
***
***
***
All the countries
0.7067
0.0139
0.0432
0.0095
0.1141***
(0.0200) (0.0014) (0.0080) (0.0068) (0.0132)
Low Debt Countries
0.7959*** 0.0139*** 0.0670*** 0.0335* 0.1125***
(0.0257) (0.0024) (0.0184) (0.0176) (0.0333)
High Debt countries
0.6752*** 0.0134*** 0.0489*** 0.0149 0.1101***
(0.0381) (0.0023) (0.0181) (0.0123) (0.0222)
Notation ***,** and * denotes 1%, 5% and 10% level of statistical significance. The vaules in the parentheses depict the
standard errors.
Commenting on the results we can observe that the coefficients of the disposable income, the
equity and housing wealth have the expected sign and are statistically significant. However, the
coefficient of government debt is positive and statistically significant (table 25) for all the group
of countries, pointing at the rejection of the Ricardian Equivalence proposition since the positive
relationship between the government debt and private consumption implies that the public debt is
perceived as net wealth for all the groups of countries. Although, we can notice that the specific
coefficient is less potent for the high debt countries and larger for the low debt countries group
which implies that in the high debt countries individuals become more concerned about the
sustainability of debt, more forward looking and hence obtain Ricardian characteristics . These
results also hold and in the case that we include the government expenditures variable in our
analysis with the difference that in high debt countries the debt coefficient becomes statistically
insignificant (table 25) implying that in high debt countries individuals do not perceive public
debt as net wealth and hence do not change their consumption accordingly. This result although
insufficient to ground the Ricardian Equivalence proposition is an indication that the individuals
in high debt countries obtain Ricardian characteristics. Though, the positive and statistically
significant coefficients of the government expenditures point in the opposite direction (table 25).
36
In order to investigate the short run effects we incorporated both our basic and the extended long
run consumption function in an autoregressive distributed lag (ADRL) model with an error
correction form as Berben and Brosens (2007) as follows:
𝑑
𝑒
ℎ
𝛥𝑐𝑖𝑡 = 𝜑𝑖 (𝑐𝑖,𝑡−1 − 𝑎𝑖 − 𝛽1 𝑦𝑡−1,𝑖
− 𝛽2 𝑤𝑡−1,𝑖
− 𝛽3 𝑤𝑡−1,𝑖
− 𝛽4 𝑔𝑡−1,𝑖 ) + 𝐺0,𝑖 (𝐿)𝛥𝑐𝑖,𝑡−1
𝑑
𝑒
ℎ
+ 𝐺1,𝑖 (𝐿)𝛥𝑦𝑖,𝑡−1 + 𝐺2,𝑖 (𝐿)𝛥𝑤𝑖,𝑡−1 + 𝐺3,𝑖 (𝐿)𝛥𝑤𝑖,𝑡−1
+ 𝐺4,𝑖 (𝐿)𝛥𝑔𝑖,𝑡−1 + 𝑢𝑡,𝑖 , 𝑖
= 1,2, … , 𝑁, 𝑡 = 1,2, … , 𝑇.
Where, 𝐺𝑗,𝑖 (𝐿) (j=0,…,4) denote polynomials in the lag operator. Our results regarding the
ADRL model estimations appear in the following tables:
Table 26 - Short run estimated coefficients of the ADRL model – basic equation
Short run coefficients / ADRL model – Basic equation
All countries Low debt High debt
-0.1819*** -0.1986** -0.2371***
Cointegration term coefficient
(0.0295)
(0.0838) (0.0404)
-0.0545
0.0815
-0.1517
Δydt-1
(0.0778)
(0.1091) (0.1149)
0.0178***
0.0162** 0.0234***
Δwet-1
(0.0054)
(0.0064) (0.0087)
***
0.1066
0.0612
0.0918**
Δwht-1
(0.0270)
(0.0372) (0.0374)
-0.0401**
0.0192 -0.0737***
Δdt-1
(0.0191)
(0.0295) (0.0263)
***
0.0072
0.0036
0.0101***
Intercept
(0.0016)
(0.0022) (0.0022)
2
R - adj.
0.5663
0.4359
0.6350
Values in parentheses denote the Std errors. ***, ** and * stand for 1%, 5% and 10% level of statistical
significance.
Table 27 - Short run estimated coefficients of the ADRL model – extended equation
Short run coefficients / ADRL model – Extended equation (including g)
All countries Low debt High debt
Cointegration term coefficient -0.2304*** -0.2940*** -0.1577***
(0.0335)
(0.0797)
(0.0349)
d
**
Δy t-1
-0.1563
-0.0273
-0.2907**
(0.0722)
(0.1061)
(0.1134)
e
***
**
Δw t-1
0.0221
0.0173
0.0359***
(0.0052)
(0.0065)
(0.0084)
h
***
***
Δw t-1
0.0896
0.0968
0.0458
(0.0248)
(0.0360)
(0.0354)
Δdt-1
-0.0442**
0.0045
-0.0642**
(0.0176)
(0.0280)
(0.0246)
Δgt-1
0.1876***
0.1432*
0.2762***
37
(0.0410)
(0.0024)
(0.0575)
***
Intercept
0.0054
0.0013
0.0073***
(0.0015)
(0.0024)
(0.0022)
2
R - adj.
0.6459
0.5125
0.6852
Values in parentheses denote the Std errors. ***, ** and * stand for 1%, 5% and 10% level of statistical
significance.
In the tables below we can observe the long run coefficients of the cointegration term:
Table 28 – long run coefficients of the cointegration term – basic equation
Long run coefficients / cointegration term – Basic equation
All countries
Low debt
High debt
ydt-1,i
-0,8493
-0,7998
-1,0260
e
w t-1,i
-0,0149
-0,0062
-0,0246
wht-1,i
-0,0528
-0,1050
0,0402
dt-1,i
0,0627
-0,0407
0,1173
Intercept
-1,6784
-0,9532
-0,9315
Table 29 – long run coefficients of the cointegration term – extended equation
Long run coefficients / cointegration term – Extended equation (including g)
All countries
Low debt
High debt
d
y t-1,i
-0,7517
-0,7574
-1,0253
wet-1,i
-0,0135
-0,0076
-0,0252
h
w t-1,i
-0,0238
0,0049
0,0727
dt-1,i
0,0385
0,0187
0,1603
gt-1,i
-0,0746
-0,1773
-0,0582
Intercept
-1,8931
-0,9345
-1,0292
From the obtained results (tables 26 and 28) we can observe that the coefficients regarding the
disposable income, the equity wealth and the housing wealth have the expected signs and are
statistically significant with few only exceptions. More interestingly, the debt coefficient is
negative and statistically significant for the all countries group, positive though not significant
for the low debt countries group while negative and statistical significant for the group of high
debt countries. Our findings in accordance with the results of Berben and Brosens (2007)
confirmed our initial expectations. Specifically, in low debt countries individuals do not perceive
public debt as net wealth and hence do not change their consuming behavior due to debt issue
(statistically insignificant government debt coefficient) On the contrary, in high debt countries
that individuals are more concerned about the sustainability of government debt and hence more
forward looking decrease their consumption as a result of the deficit financed tax cuts or
government expenditures raise. Furthermore, they increase their savings accordingly in order to
cope with the future taxes liabilities derived from these fiscal policies. These findings are in
38
favor of the Ricardian Equivalence proposition validity. Although, the incorporation of our
extended consumption function in the autoregressive distributed lag model (ADRL) yielded
positive and statistically significant coefficients for the government expenditures variable that
violate the Ricardian Equivalence proposition. Hence, we can draw the primary conclusion that
although Ricardian Equivalence is rejected for all the countries groups in high debt countries
individuals obtain Ricardian characteristics as we have discussed in our previous analysis.
From the analysis above regarding the long run and short run effects of government debt on
private consumption we can derive a very crucial conclusion. Specifically, although in the long
run the public debt coefficients are positive and statistically significant for all the groups of
countries, the relative short run coefficients are statistically insignificant for the group of low
debt countries while negative and statistically significant for the group of high debt countries.
This means that although in the long run individuals perceive the government debt as net wealth
increasing their consumption in the short run individuals do not realize the public as net wealth.
Specifically, in the low debt countries individuals do not change their consumption as a result of
a debt issue while in high debt countries they decrease it. The difference between the short and
long run effects can be explained as in the short run individuals especially in high debt countries
are more possible to be affected by the news regarding the development of government debt and
hence they become more concerned about the debt level and more forward looking. In the long
run though these short run effects diminish and the relationship between the public debt and
consumption becomes positive. The reason behind this fact is that in the long run and especially
in high debt countries individuals may face liquidity constraints. Hence, individuals are unable to
smooth their consumption and base their consumption decisions on their disposable rather than
on their permanent income as the Ricardian Equivalence Hypothesis implies. This argument is
in line with the findings of Pozzi et al. (2004) regarding the excess sensitivity of consumption as
we have already discussed in the literature review section.
8. Conclusions
The objective of this Master Thesis was to investigate the impact of government debt on private
consumption and therefore to test the validity of Ricardian Equivalence Hypothesis for different
levels of public debt. To this end we performed both a graphical and a quantitative approach.
The graphical approach and specifically the simultaneous study of the Public and Private savings
revealed an offsetting trend – negative relationship between them implying possible validity of
the Ricardian proposition for a few low debt countries and for the majority of the high debt
countries. Furthermore, from the Government debt graphs we noticed that the public debt
problem escalated for all the countries in our sample after the outbreak of the economic crisis.
To proceed with our quantitative analysis we used the long run consumption function developed
by Berben and Brosens (2007) that was allowing us to study the impact of government debt on
39
private consumption for different levels of debt namely for low and high indebted countries. In
order to investigate the long run effects we estimated our consumption function in a panel
estimation approach for different groups of countries53. For studying the short run effects, we
incorporated our long run consumption equation in an autoregressive distributed lag model
(ADRL) with an error correction framework.
The estimations regarding the long run effects revealed a positive and statistically significant
relationship between the public debt and private consumption both for the high and low debt
group of countries, though less potent for the high indebted countries, pointing at the rejection of
the Ricardian Equivalence hypothesis. On the contrary, the estimations from the ADRL model
indicated that individuals both in high and low debt countries obtain Ricardian characteristics.
Specifically, in low debt countries the corresponding coefficient was not statistically significant,
meaning that individuals in these countries don’t change their consuming behavior based on the
debt level, while negative and statistical significant for the high indebted countries. The rejection
of Ricardian Equivalence proposition in the long term could be attributed to reasons related to
liquidity constraints.
The policy implications deriving from the above stated findings concern mainly the effectiveness
of the expansionary fiscal policy. This means that a deficit financed tax cut or government
expenditures increase would be more effective in the long run and in the low debt countries
rather in the short run and in the more indebted countries.
53
The classification was based on the debt level of each country as determined by the debt to GDP ratio.
40
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43
10. Appendix
Tables 1-10 ADF tests for the National, Public and Private savings
TABLE 1 I(1) vs I(0)
Luxemburg Trend/Intercept
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
National S. Trend & intercept -2,445049 -3,277364 -3,673616 -4,532598 0,3477
Public S.
Trend & intercept -3,721996 -3,286909 -3,690814 -4,571559 0,0473
Private S.
Trend & intercept -2,394081 -3,277364 -3,673616 -4,532598 0,3703
outcome
Non Stat.
Station.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
TABLE 2 I(1) vs I(0)
Finland
Trend/Intercept
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
National S. Intercept
-2,122864 -6,655194 -3,029970 -3,831511 0,2385
Public S.
Intercept
-1,865441 -2,655194 -3,029970 -3,831511 0,3400
Private S.
Trend & Intercept 1,504573 -3,297799 -3,710482 -4,616209 0,999
outcome
Non Stat.
Non Stat.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
TABLE 3 I(1) vs I(0)
Netherlands Trend/Intercept
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
National S.
Trend & Intercept -2,321366 -3,277364 -3,673616 -4,532598 0,4040
Public S.
Intercept
-2,259446 -2,655194 -3,029970 -3,831511 0,1938
Private S.
Trend & Intercept -2,204112 -3,310349 -3,733200 -4,667883 0,4560
outcome
Non Stat.
Non Stat.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
Germany
National S.
Public S.
Private S.
Trend/Intercept
Trend & Intercept
Trend & Intercept
Trend & Intercept
TABLE 4 I(1) vs I(0)
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
-3,218456 -3,286909 -3,690814 -4,571559 0,1120
-3,606076 -3,286909 -3,690814 -4,571559 0,0581
-2,841289 -3,277364 -3,673616 -4,532598 0,2010
outcome
Non Stat.
Non Stat.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
Austria
National S.
Public S.
Private S.
Trend/Intercept
Trend & Intercept
Intercept
Trend & Intercept
TABLE 5 I(1) vs I(0)
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
-2,616893 -3,277364 -3,673616 -4,532598 0,2773
-3,782547 -2,660551 -3,040391 -3,857386 0,0116
-2,052067 -3,277364 -3,673616 -4,532598 0,5377
outcome
Non Stat.
Station.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
TABLE 6 I(1) vs I(0)
France
Trend/Intercept
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
National S. Trend & Intercept -1,976441 -3,277364 -3,673616 -4,532598 0,5764
Public S.
Trend & Intercept -3,746562 -3,297799 -3,710482 -4,616209 0,0470
Private S.
Intercept
-1,541203 -2,655194 -3,029970 -3,831511 0,4918
outcome
Non Stat.
Station.
Non Stat.
44
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
TABLE 7 I(1) vs I(0)
Belgium
Trend/Intercept
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
National S. Trend & Intercept -2,255483 -3,277364 -3,673616 -4,532598 0,4356
Public S.
Intercept
-1,936298 -2,655194 -3,029970 -3,831511 0,3100
Private S.
Intercept
-3,293571 -2,681330 -3,081002 -3,959148 0,0341
outcome
Non Stat.
Non Stat.
Station.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
TABLE 8 I(1) vs I(0)
Ireland
Trend/Intercept
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
National S. Intercept
-1,982042 -2,660551 -3,040391 -3,857386 0,2912
Public S.
Intercept
-2,249116 -2,660551 -3,040391 -3,857386 0,1974
Private S.
Trend & Intercept -4,012369 -3,324976 -3,759743 -4,728363 0,0330
outcome
Non Stat.
Non Stat.
Station.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
Italy
National S.
Public S.
Private S.
Trend/Intercept
Intercept
Intercept
Trend & Intercept
TABLE 9 I(1) vs I(0)
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
-1,710085 -2,660551 -3,040391 -3,857386 0,4097
-4,114349 -2,660551 -3,040391 -3,857386 0,0059
-2,447838 -3,297799 -3,710482 -4,616209 0,3455
outcome
Non Stat.
Station.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
Portugal
National S.
Public S.
Private S.
Trend/Intercept
Intercept
Trend & Intercept
Trend & Intercept
TABLE 10 I(1) vs I(0)
ADF stat.
P-value
𝑡𝑎∗
𝑡𝑎∗∗
𝑡𝑎∗∗∗
-1,443123 -2,655194 -3,029970 -3,831511 0,5395
-3,327566 -3,286909 -3,690814 -4,571559 0,0935
-2,714825 -3,277364 -3,673616 -4,532598 0,2419
outcome
Non Stat.
Non Stat.
Non Stat.
Notation ***,** and * depicts 1%, 5% and 10% level of statistical significance respectively.
Tables 11-14 Johansen Cointegration Tests for Public and Private savings
Lags
Finland
Nether.
11
TABLE 11 Johansen Cointegration Test
Trace Test
Max-Eigenvalue Test
Trace
0,05
PMax-Eigen Critical
PStatist.
Critical
value
Statist.
Value
Value
Value
7,311207 3,841466
0,0068 7,311207
3,841466 0,0068
Lags
12 Trace
TABLE 12 Johansen Cointegration Test
Trace Test
Max-Eigenvalue Test
0,05
PMax-Eigen Critical
P-
Outcome
One cointegrating
equation at the
0,05 level
Outcome
One cointegrating
45
Statist.
18,72890
Lags
Germany
13
Critical
Value
15,49471
TABLE 13
Trace Test
Trace
0,05
Statist.
Critical
Value
16,98267 15,49471
TABLE 14
Lags
Trace Test
Trace
0,05
Portugal
Statist.
Critical
11
Value
12,53244 15,49471
value
Statist.
Value
Value
0,0157
17,64685
14,26460
0,0141
equation at the
0,05 level
Johansen Cointegration Test
Max-Eigenvalue Test
PMaxCritical
Pvalue
Eigen
Value
Value
Statist.
0,0296 15,74495 14,26460 0,0290
Outcome
One
cointegrating
equation at the
0,05 level
Johansen Cointegration Test
Max-Eigenvalue Test
PMax-Eigen Critical
Pvalue
Statist.
Value
Value
Outcome
No cointegration
at the 0,05 level
0,1331
11,56256
14,26460
0,1282
Table 17 – Estimation of the Basic consumption function (16) in first differences
Individual Estimations – Basic Equation in First Differences
Countries
Yd
we
wh
d
*
Austria
0.2283
0.0065
-0.1103**
0.0426
(0.1111)
(0.0082)
(0.0375)
(0.0468)
Finland
0.3552
0.0033
0.0672
-0.1025
(0.2607)
(0.0161)
(0.1239)
(0.0673)
Low Debt
Netherlands 0.2227* 0.0332*** 0.2724*** 0.0947**
(0.1089)
(0.0100)
(0.0405)
(0.0322)
Germany
0.8649*** 0.0162*** 0.1830** 0.0471**
(0.1325)
(0.0051)
(0.0772)
(0.0227)
***
France
0.5420
0.0181**
0.0693*
0.0065
(0.1213)
(0.0084)
(0.0333)
(0.0391)
Belgium
0.3579**
0.0183
-0.0566
-0.0431
(0.1671)
(0.0118)
(0.0915)
(0.1077)
Ireland
0.2099
0.0471
0.2140**
-0.0378
High Debt
(0.2345)
(0.0227)
(0.0868)
(0.0564)
Italy
0.4355** 0.0496***
0.0954
-0.1321
(0.1854)
(0.0133)
(0.0905)
(0.1467)
Portugal
0.6862***
0.0023
0.0837
-0.1148
(0.1884)
(0.0172)
(0.1232)
(0.0800)
Notation: ***,** and * depict 1%, 5% and 10% level of statistical significance. Values in parentheses denote the Standard
Errors.
Table 18 – Estimation of the Extended consumption function (17) in first differences
46
Individual Estimations – Extended Equation (including g) in First Differences
Countries
Yd
we
wh
d
g
**
Austria
0.2895
0.0062
-0.1151*** 0.0738
-0.1361
(0.1250)
(0.0082)
(0.0376)
(0.0552) (0.1289)
Finland
0.1479
0.0132
0.0905
-0.0581
0.4917
(0.2867)
(0.0168)
(0.1202)
(0.0712) (0.3298)
Low Debt
Netherlands 0.2223*
0.0250*
0.2858*** 0.0833** -0.0964
(0.1069)
(0.0118)
(0.0412)
(0.0329) (0.0771)
***
Germany
0.8945
0.0188***
0.1440*
0.0352
0.1143
(0.1277)
(0.0051)
(0.0777)
(0.0229) (0.0723)
France
0.5903*** 0.0166*
0.0734**
0.0199
-0.1204
(0.1326)
(0.0086)
(0.0337)
(0.0419) (0.1302)
Belgium
0.3569*
0.0188
-0.0590
-0.0446
0.0114
(0.1738)
(0.0144)
(0.1016)
(0.1140) (0.1796)
Ireland
0.0584
0.0507
0.1542*
-0.0070
0.2227
High Debt
(0.2411)
(0.0299)
(0.0872)
(0.0526) (0.1421)
Italy
0.3125
0.0464***
0.0304
-0.2161
0.2099
(0.1410)
(0.0033)
(0.7642)
(0.1836) (0.1848)
Portugal
0.8247***
0.0006
0.1358
-0.1153 -0.1168
(0.2398)
(0.0174)
(0.1356)
(0.0803) (0.1244)
Notation: ***,** and * depict 1%, 5% and 10% level of statistical significance. Values in parentheses denote the Standard
Errors.
47