Posted by: Tobias | September 25, 2008

Testing Ricardian equivalence in real time

Way back when I was taking Advanced Macroeconomics, my professor remarked in class that to him the question of whether Ricardian equivalence held empirically was still an open question.

For the uninitiated, Ricardian equivalence is an idea due to Nobel Prize winner Robert Barro, which holds that fiscal policy interventions, e.g. the government spending more money or sending people tax rebate cheques, will not have any influence on the macroeconomy and therefore be entirely ineffective. You see, in the flavor of macroeconomics that Barro advocates everyone has full information about what’s going on all over the economy and can anticipate the result of every action taken by the various actors in the economy. And if this is the case, Barro holds, a consumer that gets a rebate cheque in the mail will realize immediately that all this extra money the government is handing out has to come from somewhere. In fact, since raising taxes to finance these expenditures would be contractionary, the only way for the government to finance these expenditures is a higher deficit. And knowing that any debt has to be paid back sooner or later, the consumer will not spend the additional money the government sent his way, but will instead put it in a savings account and wait for the day when the government inevitably raises taxes to pay off its debts.

Sound crazy to you? You’re in good company. And apparently, the latest empirical work on the question, this time in almost real time, isn’t so kind on the idea either:

The great thing about new-century economics is we can empirically verify. And increasingly we can do it in real time, as Christian Broda and Jonathan Parker have done with their analysis of America’s 2008 tax rebate. Turns out, the tax rebates are working.

Their method is simple. Using real-time daily consumption data for 34,000 households (from a Nielsen database), they check whether consumption jumps when households get their rebate cheques. Since the mailing of the cheques was spread over a couple of months, but the timing was random as far as households were concerned, they just compared household spending for those that got cheques with those that didn’t (controlling for all sorts of idiosyncratic household features).

The rebate boosted typical family spending on food, mass-merchandise and drug products by 3.5%, with the impact being highest in the week the cheque arrived (almost 6%); they found no impact on spending in the weeks prior to the receipt of the rebate, even though all household knew in principle that the cheque was in the mail, so to speak.

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Responses

  1. Although I am not surprised people spending instead of saving it I surprised me with what speed people are spending it.
    (I wonder how the world would look like today if the Ricardian equivalence had been common practice?)


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