BUDGET DEFICITS AND RICARDIAN EQUIVALENCE : A CRITICAL EVALUATION

Abstract

The effect of government fiscal policy has become a controversial issue in recent years. It has been found by many authors that a substitution of debt for taxes results in negligible effects on consumption, savings , interest rate and economic growth, while others have argued otherwise. The conditions under which Ricardian equivalence holds is extremely stringent and has been criticised as being one of the reasons why Ricardian equivalence cannot and does not hold exactly. Empirical evidence so far have been mixed. Some have argued that this is due to the different methodology adopted as well as to errors of model specifications but others have argued that the different specifications do not make a difference. An attempt in this exercise is made to test the relevance of Ricardian equivalence in ASEAN. The empirical evidence does not support Ricardian equivalence. However, this does not mean that Ricardian equivalence is to be totally rejected. This is especially so in cases where government deficit or debt is found to have insignificant effects, which indicates that Ricardian equivalence is able to hold approximately, if not exactly. Ricardian equivalence will continue to be an issue of debate as long as the issues of methodology and specification are not corrected. Further research is still being done in this area to produce more definitive results.