Abstract
The objective of this paper is to test the existence of Ricardian Equivalence in Lesotho using annual data for two sample periods, 1980–2014 and 1988–2014. This proposition is important and has crucial implications for tax policy. Household consumption, government debt, government expenditure, GDP per capita, population growth and inflation are variables which are used for this analysis. The study used ARDL cointegration approach to investigate the relationship between these variables. The study found that there is long run equilibrium relationship among the variables in two sample periods. The results show that an increase in government debt or government expenditure will decrease household consumption per capita. This implies that the Ricardian Equivalence does hold for Lesotho. The results also imply that fiscal policy is an ineffective tool to stabilize the economy. Lesotho has limited fiscal flexibility, and it will be difficult or challenging to increase private consumption and economic growth, particularly during economic downturn.
Highlights
The term “Ricardian Equivalence” hypothesis has been a subject of too many macroeconomists since it was pioneered by Ricardo in the 1820s
In model 1, the results indicate that there is a negative relationship between government expenditure and household consumption per capita
The results for model 1 show that there is a negative relationship between government expenditure and household consumption per capita
Summary
The term “Ricardian Equivalence” hypothesis has been a subject of too many macroeconomists since it was pioneered by Ricardo in the 1820s. The proposition states that rational consumers are forward looking and internalize government budget constraint when making their expenditure decisions. Ogba (2014) explained that there are two dimensions to deal with government debt effect. The first one is the Keynesian view, which posits that an increase in government debt due to tax cut raises disposable income and stimulates the demand side of the economy. The second one is the Ricardian Equivalence, where consumers reduce their current consumption in order to pay for future tax increase. These result in aggregate demand to be the same as if government had chosen to increase tax and not later
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