Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 157: Real Effects of Budget Deficits? - Theory and Evidence

Torbjörn Becker and Anders Paalzow ()
Additional contact information
Torbjörn Becker: Department of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden
Anders Paalzow: Department of Economics, Postal: Stockholm School of Economics, Box 6501, 113 83 Stockholm, Sweden

Abstract: This paper investigates the real effects of debt or tax financing of a given level of government consumption. The paper starts with a survey of the theoretical literature, ranging from Ricardian to Keynesian models. The conclusion from the survey is that the real effects of budget deficits are ambiguous, in some cases private consumption increases, and in other it decreases. The second part of the paper provides an empirical study of Ricardian equivalence in Sweden. The methodological framework is a vector autoregressive model with long run restrictions implied by the public and private sectors' intertemporal budget constraints. The empirical analysis indicates that the Ricardian view of fiscal policy is more in line with the estimated model than the Keynesian view. A permanent change in public consumption crowds out private consumption, while a temporary change in taxes leaves private consumption more or less unchanged.

Keywords: Public debt; private consumption; Ricardian equivalence; sustainability; cointegration

JEL-codes: H60; H31; E60; E21 January 1997

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