Ricardian Equivalence: Some Macro-Econometric Tests for Pakistan (Fiscal AND MONETARY Policies) (Report‪)‬

The Ricardian Equivalence Hypothesis (REH) since resurrected by Barro (1974) states that deficit financing and taxation produce the same intertemporal allocation of consumption. To establish his theorem, Barro has to make a number of restrictive assumptions such as: all government revenue is collected by lump-sum taxation, debt is believed to be eventually repaid, capital markets are perfect, there is no uncertainty and agents are 'effectively' infinite-lived. To motivate the last assumption, Barro shows that because of purely altruistic motives, the agents derive utility from the welfare of their children and their grandchildren and so on such that through the inter-generational transfers, they act virtually like the infinitely lived. With the publication of Barro's seminal paper, a flood of theoretical and empirical literature on Ricardian Equivalence has emerged which was published mostly in the 1970s and 1980s. A complete review of the literature is not possible. However, it must be pointed out that not a single study to the author's knowledge, has appeared dealing with developing countries. Kochin (1974); Aschauer (1985); Kormendi (1983); Leiderman and Razin (1988) have produced empirical support for the Ricardian Equivalence Hypothesis using data on USA, Canada and other developed countries. On the other hand, Buchanan (1986); Brennen (1987); Modigliani, Jappali and Pagano (1985); Feldstein (1976); Feldstein and Elmendorf (1987); Haque (1988); Buiter and Tobin (1980); Poterba and Summers (1988) produce evidence which is generally inconsistent with the basic logic of the Ricardian Equivalence Hypothesis. The overall reviews of the debate are presented in Bernheim (1987); Boskin, Flamming and Gorini (1987); Bernheim (1989) and Leiderman and Blajer (1988), which generally come to the conclusion contradicting the findings of the Ricardian Equivalence Hypothesis. A comprehensive review of REH literature is given in Kazmi (1991).