Research Discussion Papers, Bank of Finland
No 6/1997:
Current Income and Private Consumption-Saving Decisions: Testing the Finite Horizon Model
Anne Brunila ()
Abstract: This paper considers the effects of fiscal policy on
private consumption in a framework that encompasses both the conventional
(Keynesian) view of fiscal policy and the Ricardian debt neutrality
hypothesis. The model is built on Blanchard's stochastic model of
intertemporal optimization with finitely lived consumers. As an extension
to the basic framework public consumption is explicitly incorporated in the
model. The model nests also the excess sensitivity hypothesis whereby the
role of current income on consumption can be investigated. Empirical
analyses are based on annual data from ten EU countries covering the years
1961–1994 and use the nonlinear instrumental variable GMM estimator both in
country-specific and panel estimations. The tests reject clearly the
Ricardian debt neutrality for majority of the countries in the sample.
Moreover, deviations from Ricardian neutrality seem to arise from excess
sensitivity of consumption to current income rather than from a finite
planning horizon on the part of consumers. The results also suggest that in
the consumers' utility functions, government consumption and private
consumption tend to be unrelated or complements rather than substitutes.
Keywords: private consumption; private saving; current income; fiscal policy; planning horizon; (follow links to similar papers)
72 pages, May 14, 1997
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