AGGREGATE CONSUMPTION AND DEFICIT FINANCING: AN ATTEMPT TO SEPARATE PERMANENT FROM TRANSITORY EFFECTS

Many previous empirical studies of the Ricardian Equivalence Hypothesis have found a relatively high degree of future tax liability discounting such that current deficits appear to have relatively little or no influence on current consumption demand. However, the validity of these empirical estimates can be questioned as they may not have adequately distinguished between permanent and transitory income flows. This paper attempts to address this problem by using cycle‐averaging as a simple method of capturing the permanent path of income over time. The empirical evidence generated in this paper rejects the strict debt neutrality proposition of the Ricardian Equivalence Hypothesis.