Government debt and budget deficit nexus in Pakistan: Evidence for Ricardian Equivalence Hypothesis

Abstract

We checked the validity of Ricardian Equivalence Hypothesis in Pakistan by using structural consumption and saving function. By using ordinary least square method we checked the restrictions of Ricardian equivalence hypothesis that has been rejected by the vale of Wald test. The Engel-Granger causality approach explored uni-directional causality between Government Debt & Private Consumption and Government Debt & Private Saving whereas Bidirectional Causality exists between Government Budget Deficit & Private Saving. Hence, we concluded that fiscal policy is effective in case of Pakistan because Ricardian Equivalence does not hold in Pakistan that indicated the policy makers to use fiscal policy as a stabilizing policy of the economy.