Does Ricardian equivalence hold in Australia? A revision based on testing super exogeneity with impulse-indicator saturation

What is it about?

Following the 2008–2009 Global Financial Crisis, many countries, including Australia, enacted fiscal stimulus packages in the hope of reviving their economies by encouraging aggregate demand. For the success of these efforts, it is vital that fiscal policies have some positive impact on the real economy. However, tax reductions and cash handouts are virtually ineffective if consumers are Ricardian and internalise the intertemporal budget constraint of the government. This paper aims to test the Ricardian equivalence hypothesis for Australia from 1960 to 2011 by exploiting the links between (1) Ricardian equivalence and the Lucas critique; (2) the Lucas critique and super exogeneity, and (3) testing for super exogeneity with impulse-indicator saturation. As there is no evidence of a structural break in the conditional model for the growth rate of per capita real gross domestic savings, we conclude that policy-regime shifts did not lead to substantial changes in the estimated relationship, so the Lucas critique does not apply. Consequently, our results indicate that during the past half-century Ricardian equivalence held in Australia. This implies that tax and cash bonuses of the government may not lead to the desired economic outcomes as Ricardian-type consumers tend to offset the dissaving of the government by saving more and leaving household consumption unchanged.

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