Testing the Ricardian Equivalence Theorem: Time Series Evidence from Greece

Abstract

The paper explores the long-run relationship between government domestic borrowing and private savings for a small EU country. It represents an attempt to assess the relevance of Ricardian Equivalence in Greece. The empirical findings are that in accordance to the Ricardian Equivalence theorem prediction, government borrowing in Greece leads to an increase in household savings. However, the increased private savings do not completely offset increased government debt. In other words, contrary to the Ricardian Equivalence theorem, households to some extent perceive government bonds as net wealth and consequently increased their consumption. This behaviour can be thought as being the result of liquidity constraints faced by households and also myopic behaviour due to uncertainty regarding the future path of taxes.