Revisiting Ricardian Equivalence Hypothesis (REH) For Pakistan Using Money Demand Function Approach

Saima Sarwar

Journal of Empirical Economics, 2015, vol. 4, issue 3, 154-166

Abstract: Budget Deficit has been a crucial and highly debated issue in developing world. There have been some theories of fiscal policy to analyze the association between accelerating budget deficit and macroeconomic performance. Major harmful effects of it are increase in high rate of interest, low savings, low growth rates, large current account deficit. The objective of this study is to explore the relationship between these two variables for the case of Pakistan. Johansen cointegration is applied to check the causality between these two major variables along with many other important macroeconomic variables incorporated in money demand function. Data used spans from 1970–2014. Findings of the empirical analysis verify the implications of Keynesians theory in Pakistan and rejection of Ricardian Equivalence Hypothesis (REH). Results show that there exists short run and long run relationship between budget deficit and money demand and error correction estimate shows that more than 100% disequilibrium in real money demand is corrected per annum. Moreover diagnostic tests of residuals prove the stability of model. This stability of money demand function has many policy implications for monetary and financial authorities.

Keywords: Budget Deficit; Money Demand; Consumption; Interest Rate; Inflation; Johansen Cointegration; Government Expenditure; VECM. (search for similar items in EconPapers)
Date: 2015
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