The Ricardian equivalence proposition: evidence from foreign exchange markets

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The major argument against running large government budget deficits is that they raise interest rates and crowd out real investment. Conclusive evidence of a relationship between large budget deficits and high interest rates has not been found. Two competing explanations are tested by examining the impact of government udget announcements on foreign exchange rates. The Ricardian equivalence proposition that deficits have no crowding-out effects is compared to the conventional open economy hhypothesis that capital mobility transfers these effects to foreign exchange rates. The results supports the open economy hypothesis over the Ricardian equivalence proposition. (JEL F41).