Evaluating the Keynesian Absorption Theory and Ricardian Equivalence: An Empirical Analysis Incorporating IMF Interventions

Abstract

The study aims to investigate the national data for possibility of the Ricardian equivalence or Keynesian absorption theory, and impact of IMF reform policies on validating theoretical framework, which in turn, ascertain the acceptance of either Ricardian equivalence or Keynesian absorption theory. The data is collected from different sources including the Pakistan Economic Survey, the State Bank of Pakistan, and World Development Indicators that covering the period 1987-2022. The analysis tools involve ADF, PP, Johansen cointegration, ARDL, VECM and VAR in causality to achieve the research objective. Using VECM, the results reveal that debt, GDP, budget deficit and government expenditure have a statistically significant relationship with consumption. The restrictions based on two distinct views indicates the validation of Ricardian equivalence theory while rejecting the Keynesian absorption theory in Pakistan. The causality in VAR also validates the existing findings, indicates causality is not running in either direction between two deficits, and hence no relationship between two deficits, and ensures the existence of Ricardian equivalence theory. Finally, the IMF policy indicates an insignificant impact on consumption and validates the Ricardian equivalence viewpoint. Findings imply that government should increase the taxes over bond holders than non-bond holders to reduce burden on those who did not save.