An Examination of the Validity of Ricardian Equivalence Hypothesis in Nigeria

Abstract

This study tested the validity of Ricardian Equivalence Hypothesis (REH) econometrically using quarterly data from the period 1985Q1 to 2014Q4. Autoregressive Distributed Lag (ARDL) bound test as developed by Pesaran, Shin and Smith (2001) was employed to investigate the dynamics of the long-run relationship streaming from disposable income, government final consumption expenditure, government debt, government budget deficit to private consumption expenditure. More remarkably, increased government spending is instigated by the rapt choice of debt and tax. The result of the study demonstrated that, REH does not hold in Nigeria because debt is considered as net wealth and consumers neither live forever nor become concerned about the next generation as much as they care about themselves. Equally, REH proposition has been invalidated by the standard Wald test on the ground that, capital markets are imperfect with borrowing constraints; private and public sectors have different planning horizons and taxes are distortionary in Nigeria.Therefore, increase in government spending rely on the fiscal capacity of Nigeria and the political process. Results of this study however draw attention to the efficacies of fiscal policy in expanding private consumption, controlling budget deficit and macroeconomic stabilization in Nigeria.

Keywords: Ricardian equivalence hypothesis, ARDL model, bound testing, debt for tax swap.