New Historical Evidence Against Ricardian Equivalence in Australia

Authors


  • We are grateful to the anonymous referees for their helpful comments. Of course, all remaining errors are ours.

Bekzod Abdullaev, School of Economics, La Trobe University, Bundoora, 3086, Melbourne, VIC, Australia. Email: b.abdullaev@latrobe.edu.au

Abstract

The Ricardian equivalence hypothesis states that, under certain conditions, the decision to finance public expenditure via higher taxes or by issuance of government bonds is irrelevant for private consumption decisions. It is assumed that consumers are fully rational and aware that current and future public spending has to be eventually paid off. Thus, the present value of public expenditures reduces the consumer’s permanent income and changes in the intertemporal allocation of taxes only affect private savings, leaving consumption unaffected. On the other hand, if consumers behave in accordance with the Keynesian hypothesis, then government spending has a positive effect on private consumption. We test the validity of the Ricardian equivalence hypothesis for the Australian economy on three Euler-type consumption functions using a new historical dataset covering the period of 1901–2007. The analysis is performed in three versions: on all available observations without and with dummy variables for WWI, the Great Depression and WWII, and on a subsample that excludes the years when those turbulent events took place. In most cases there is ample evidence against Ricardian equivalence suggesting that fiscal policy can play a stabilising role in Australia.

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