Exogenous tax changes and interest rates: testing for Ricardian equivalence using an efficient markets model

Tony Caporale

Applied Economics, 2015, vol. 47, issue 59, 6390-6394

Abstract: This article tests the Ricardian theory (i.e., Barro 1974) using Mishkin's (1981, 1982) efficient markets model of interest rates. Employing Romer and Romer's (2010) measure exogenous tax changes, I am able to test whether the U.S. bond market reacts in a Keynesian or Ricardian manner to exogenous tax policy changes. This helps avoid the endogeneity problems associated with measuring the interest rate effects of deficits and provides a cleaner test of the pure Ricardian thought experiment. I find a significant negative relationship between tax changes and interest rates which is inconsistent with the Ricardian model and support the Keynesian crowding out framework.

Date: 2015
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DOI: 10.1080/00036846.2015.1071473

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