LIQUIDITY CONSTRAINTS AND RICARDIAN EQUIVALENCE IN ESTONIA Hannes Kaadu Lenno Uusküla* December 2004 Working Papers of Eesti Pank No 7, 2004

This paper aims to find evidence of the influence of government deficit on private consumption in Estonia. The data only shows some support for Ricardian equivalence. Two approaches were used in the empirical tests. The Haque and Montiel (1989) equation of consumption was estimated using an instrumental variables technique. The Aschauer (1985) system of equations was estimated with the full information maximum likelihood method. Formal tests based on macro data could neither reject nor confirm the existence of liquidity constraints or Ricardian equivalence. There remains a lot of room for testing both of these hypotheses in Estonia. Further efforts to test liquidity constraints should concentrate on using micro data.
JEL Code: E21, E62, H62
Key words: Ricardian equivalence, liquidity constraints, Estonia

* The authors would like to thank Martti Randveer, Tairi Rõõm and participants of the seminar held at Eesti Pank for their valuable comments.

Authors' e-mail addresses: hannes.kaadu@tukkk.fi, lenno.uuskyla@epbe.ee

The views expressed are those of the authors and do not necessarily represent the official view of the Eesti Pank.

Contents

Introduction

1. Consumption Theory, Liquidity Constraints and Ricardian Equivalence

1.1. Consumption and Ricardian Equivalence

1.2. Liquidity Constraints and Finite Planning Horizons

2. Government and Private Consumption in Estonia

2.1. Government Deficit and Debt

2.2. Income, Consumption and Liquidity Constraints

3. Empirical Results

3.1. Tests for Liquidity Constraints

3.2. Rational Expectations Approach

Conclusions

References

Appendices

Appendix 1. Haque and Montiel (1989) Model Constraints

Appendix 2. Description of Variables

Liquidity Constraints and Ricardian Equivalence in Estonia, Working Papers of Eesti Pank No 7, 2004 (PDF*)

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