Ricardian equivalence and positively sloped IS curve: (Dis)equilibrium insights

Xakousti Chrysanthopoulou, Moise Sidiropoulos and Alexandros Tsioutsios

The Journal of Economic Asymmetries, 2024, vol. 30, issue C

Abstract: In the New-Keynesian model augmented with non-Ricardian households (breakdown of the Ricardian equivalence), the elasticity of aggregate demand to changes in real interest rate is linked non-linearly to the share of non-Ricardian households. Importantly, this dependence may result in an upward-sloping dynamic New-Keynesian IS curve. Using an extended fractionally cointegrated VAR model in a recursive framework, we empirically test this for the US from 1959 to 2024, finding a positive long-run relationship between consumption and interest rates from 1980 to 1992, and a negative one from 1993 onwards, with a stronger negative correlation after 2000. These results suggest shifts in asset market participation, altering equilibrium dynamics in the goods market. We analytically show that when non-Ricardian households surpass a certain threshold, output adjusts to excess supply rather than demand, imposing novel restrictions on the New-Keynesian Phillips curve to maintain equilibrium determinacy. These bounds on the New-Keynesian Phillips curve slope under varying inflation targeting rules offer a new perspective on monetary policy design.

Keywords: Limited asset market participation; Dynamic IS curve; Dynamic stability; Ricardian equivalence; Determinacy; FCVAR (search for similar items in EconPapers)
JEL-codes: E20 E44 E58 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:joecas:v:30:y:2024:i:c:s1703494924000343

DOI: 10.1016/j.jeca.2024.e00385

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