Ricardian equivalence and the Irish consumption function: the evidence re-examined

Abstract

The Ricardian Equivalence hypothesis states that economic agents perceive the future tax liabilities implicit in government debt issue and thus that increasing government expenditure partially crowds out private sector consumption through its effects on perceived permanent income. Thus, Ricardian equivalence implies that not only does a contraction of government expenditure provoke offsetting effects on aggregate demand but that it also leads to an increase in indirect tax revenues, thus setting in train a relatively painless cycle of debt reduction. Moore (1987) has presented results, based on tests from US literature, which he concluded provided strong evidence in favour of the hypothesis. Walsh (1988) confirmed that Moore's favoured econometric result was robust to data revisions and changes in data definition. Furthermore, Giavazzi and Pagano (1990) have discussed the notion of government spending reductions increasing private consumption to suggest a demandside explanation of Ireland's post-1987 experience of fiscal retrenchment combined with economic recovery while McAleese (1990) has referred to Moore's results in a similar context.