FSS-ECON Seminar: Is Public Debt Neutral under Money Financing? New Evidence from Developing Countries

Speaker: Prof. Ahmed M. KHALID, Professor, UBD School of Business and Economics, Universiti Brunei Darussalam

Date:24 Apr 2024 (Wed)

Time:14:00 – 15:15

Venue: E21B-G002

Language: English

Abstract: Contrary to the conventional macroeconomic theory the Ricardian Equivalence Proposition (henceforth, REP) negates the real economic effects of debt-financed fiscal deficits. Although, this proposition is based on some very unrealistic assumptions leading to its invalidity, the empirical evidence is non-conclusive, some rejecting the proposition while others supporting its validity. The scenario becomes even more difficult when debt is financed though inflationary financing (printing money) instead of taxes. Since inflationary financing has distortionary effects, it invalidates the basic underlying assumption of the REP which allows only lump-sum taxes. This situation is true for most developing countries which have an inefficient system of taxation and a lack of a well-established financial/bond market. Therefore, the aim of this paper is to test the validity of REP under money-finance fiscal deficits. We develop an Overlapping Generation Model (OLG) using money balances as an argument in the utility function and then test the model using the full-information maximum likelihood (FIML) techniques for a sample of developing countries. The initial results indicate a wide rejection of the REP. The absence of an infinite horizon seems to be the main source of the rejection of REP in our sample.