Testing Keynesian Proposition And Ricardian Equivalence: More Evidence On The Debate

Abstract

This paper takes its motives from recent literature concerning the debate on the Keynesian proposition and the Ricardian equivalence, using data of the Greek economy and applying cointegration analysis, Granger causality tests and impulse response functions (IRF). The aim of the econometric methodology is to derive robust results by means of using alternative quantitative techniques. The empirical analysis shows the existence of dynamic relationships between the budget deficit and the interest rate, indicating a two-way causality between deficits and interest rates. The findings of Granger tests and IRFs contradict the view of Ricardian equivalence that government deficits do not influence the behavior of interest rate. Experimenting with the four-variable system (R, D, Y, P), IRF results show that in the case of Greece the budget deficit positively affects the inflation rate. The evidence that budget deficits exert positive effects on interest rates and inflation is consistent with the rationale of the Keynesian proposition.