Empirical Economics (2005) 30:115–135

DOI 10.1007/s00181-004-0223-7

Fiscal policy and private consumption behaviour:

The Spanish case
Agustı́n Garcı́a, Julián Ramajo
Department of Applied Economics, University of Extremadura, Campus Universitario,
Avenida de Elvas s/n, Badajoz, 06071, Spain (e-mail: {agarcia; ramajo}@unex.es)

First revision received: March 2003 / Final version received: October 2003

Abstract. In this article we analyse whether the Ricardian equivalence

hypothesis is a valid approximation for Spain’s economic reality or whether
there exist deviations from that situation which would be more in line with the
conventional Keynesian perspective of the effects of debt on private con-
sumption-savings decisions.
Our aim is to contribute to the rather sparse empirical literature on the
subject for the Spanish case. The analysis is based on annual aggregate data
for Spain covering the years 1955 to 2000, and uses both the structural and
the Euler equation approaches to test the neutrality proposition, and is thus
to be considered as a generalization of foregoing work on the Spanish
economy.
The findings indicate that support for Ricardian equivalence is mixed, while
we also find very little support for the Keynesian specification of consumption
and fiscal policy.

Key words: Private consumption, fiscal policy, Ricardian equivalence, finite

horizons, liquidity constraints

JEL classification: C32, E21, E62, H31, H60

The authors wish to thank M. Ferré, J.M. González-Páramo, A. Marchante, P. Meguire, F.

Pedraja, J.L. Raymond, J. Salinas and two anonymous referees for their helpful comments and
suggestions on this paper. We also thank the participants in the V Encuentro de Economı´a
Aplicada (Oviedo, Spain, June 2002) and the XVII Simposio de Análisis Económico (Salamanca,
Spain, December 2002) for their comments. Any remaining defects are our responsibility. We also
are grateful to the Institute for Fiscal Studies of Spain (Ministerio de Hacienda, Secretarı́a de
Estado de Hacienda) for its financial support.
116 A. Garcı́a, J. Ramajo

1. Introduction

Perhaps there is no question of fiscal policy that attracts more controversy in

the recent literature than the Ricardian equivalence hypothesis (REH). The
proposition of Barro (1974) to return to Ricardian arguments on the effects of
public debt has such important implications for the effectiveness of fiscal
policy that it is not at all surprising that the topic has become a major focus of
theoretical and applied research.
As it is known, from a theoretical standpoint the stabilizing role of fiscal
policy is based on the repercussions that government decisions (on the levels
of expenditure and its financing) have on private consumption and saving.
The Keynesian view assumes that individuals perceive public debt as net
wealth and alter their patterns of consumption in response to variations in the
debt in circulation. Substituting taxation with public debt hence has major
implications for aggregate demand. Whatever the case, the possible effects of
a government’s financial decisions are the subject of controversy, since
stimulating aggregate demand in the short term might lead to lower growth
rates in the long term by way of the negative effects of interest rates on capital
accumulation.
At the opposite extreme, there is the Ricardian view which even sheds
doubt on the short-term effects of fiscal policy by denying that consumers
perceive debt as net wealth. Thus, a tax cut that generates deficit and debt
leads the private sector to increase its saving, with the disappearance of any
repercussions on the interest rate and capital accumulation. The importance
of this result is that it seriously questions the stabilizing potential of fiscal
policy.
The fundamental objective of the present work is to study the effects of
public deficit and its financing on private consumption1, using for that pur-
pose data on the Spanish economy. Our perspective will basically be infer-
ential, testing whether the neutrality hypothesis can be regarded as a valid
approximation to the Spanish economic reality or whether, on the contrary,
there exist deviations from this situation, which would be more in line with
the conventional Keynesian view of the effects of debt on private consump-
tion-savings decisions.
Overall, our study represents a generalization of foregoing work using
Spanish data. Thus, when we take the structural approach, we shall use one
functional form that enlarges on those used by other authors. Unlike previous
work, however, we shall make an explicit separation of the long and the short
term using the econometric techniques of cointegration theory and we shall
present ECM estimates of the selected specification.

1
We therefore do not analyse other possible effects of budgetary policy, for example on interest
rates or exchange rates.
Fiscal policy and private consumption behaviour: The Spanish case 117

Since there are major limitations in the structural approach (of which we
shall give details in Sect. 2), one might therefore reasonably doubt the
empirical validity of the results obtained with such approach.2 Therefore, we
shall extensively use the techniques of Euler equations with their solid the-
oretical foundations.3 As a by-product of this second analysis, we shall also
study the problem of the relationship between public expenditure and pri-
vate consumption, asking whether a significant substitution relationship
exists between the two. In this sense, we shall give new estimates for the
crowding-out effect of public consumption on private consumption com-
plementing the results obtained with the structural specification.
Our conclusions will question the findings reported by other workers for
the Spanish case, clearly rejecting the specifications that are deduced from the
Keynesian view of consumption, and accepting, although only partially, the
Ricardian equivalence hypothesis.
The article is structured as follows. Section 2 presents a synthesis of the
usual theoretical foundations to serve as the basis for the subsequent iden-
tification and explanation of some of the effects of public deficit in the em-
pirical work. Also Sect. 2 gives a review of what has been done in this area for
Spain, and introduces the models that will later be estimated. Section 3 re-
ports the results obtained, and finally Sect. IV offers some concluding re-
marks.

2. Theoretical model and empirical literature

The fundamental idea behind the result of Ricardian equivalence is that an

individual’s consumption is unaltered by whether the government decides to
finance public expenditure by taxation or by debt4. Financing the deficit by
issuing bonds is simply translated into putting off the payment of taxes, since
it is assumed that future tax increases are implicit in debt. It hence does not
represent wealth for families and does not affect their current consumption
possibilities.
The starting point for any empirical work that attempts to test the validity
of the REH is usually to model consumption behaviour in terms of the
common problem of inter-temporal maximization where the family’s utility is

2
Structural consumption functions are at best approximate reduced forms of a theoretical
general-equilibrium model and at worst bear no relationship to any well-known model of
consumer behaviour (Auerbach and Kotlikoff 1983). Even more, if it can be interpreted as a good
approximation to a reduced form, its parameters confound structural and expectational
parameters (Evans 2001).
3
Also Euler approach relies heavily on a number of auxiliary assumptions necessary to
(over)identify the equations being estimated –among others, a specific functional form of the
utility function must be imposed, rational expectations must be assumed, both individuals and
government use the same interest rate, and the taxes are lump-sum. Failure of these or other
maintained hypotheses –for example, household technology/tastes may shift over time,
intergenerational externalities might exist, or liquidity constraints might be binding– might
result in rejection of the approach.
4
Indeed, Barro (1974) showed that all important aggregate and distributional variables will be
neutral to debt if the assumptions behind the standard Ricardian model hold.
118 A. Garcı́a, J. Ramajo

considered to depend on the discounted value of the sum of the instantaneous

utilities. The problem incorporates the public sector inter-temporal budgetary
constraint and the consumers’ inter-temporal budgetary constraint. Follow-
ing Barro (1989), taking public debt as one of the assets making up a family’s
wealth and future taxation as one of its liabilities, one has that the variation in
family wealth due to that debt will be5:
Z1 Z1

rt
At ¼ D t
Et IPt e dt ¼
Et GPt e
rt dt
t t
where non-human wealth (A) is the difference between the family’s assets and
liabilities and r is the interest rate. We take public expenditure (GP), assumed
to be exogenous, to be financed by either a non-distorting (lump-sum) tax
(IP) or debt (D).
This is the relevant expression for family wealth, and indicates that con-
sumers’ decisions are unaltered by changing the debt-tax mix, i.e., one has the
Ricardian equivalence result. Private consumption is conditioned by the level
of public expenditure but not by how it is financed. The time at which taxes
are levied will not affect the representative family’s budgetary constraint.6
Debt financing a tax cut does not represent any decrease in the tax burden
borne by consumers, they simply perceive debt equivalent to delayed taxes.
The public deficit will therefore lead to an increase in private saving, not in
private consumption. This result clearly has major implications for the
effectiveness of fiscal policy.
It has to be noted, however, that the results deriving from the REH are
highly sensitive to very restrictive assumptions. If any of these assumptions
ceases to hold7, this could lead to a consumption behaviour that is sensitive to
the trade-off between debt and taxation in financing the deficit.8
The arguments described in the theoretical literature might seem enough
to justify the rejection of the REH, at least in its "strong form". However,
there is instead a general conviction that the true acid test of the REH is to
contrast the different models with the data of economic reality.9

5
This development is based on the model of Ramsey (1928). Similar approaches with a finite
temporal horizon and overlapping generations may be found, for example, in Blanchard and
Fisher (1989) and Romer (2001).
6
Also, the assumption of non-distorting taxation (lump-sum taxes) means that there is no
relevance in optimal path analysis of taxes.
7
Deviations from Ricardian equivalence that have been suggested in the literature include (Seater
1993; Smetters 1999): the presence of non-altruistic agents, childless families, finite horizons,
binding borrowing constraints, distortionary labor taxation, exchange/strategic bequests,
endogeneous fertility, ‘impure’ altruism, earnings uncertainty, etc.
8
However, some work in the last years has proved some robustness of theoretical foundations of
Ricardian equivalence. For example, in a recent work, Smetters (1999) shows that the long-run
capital intensity is robust to practically every criticism of the above footnote. In short, the work
of Smetters and others show that Ricardian equivalence is far more theoretically robust than is
commonly believed and that the majority of criticisms of the REH are not valid asymptotically in
general equilibrium.
9
Following a different approach, Cardia (1997) generates simulated data consistent with a
Blanchard-type model that has the REH nested within a non-Ricardian alternative. The results of
that work indicate that the standard tests are incapable of providing conclusive evidence on
whether or not the neutrality proposition is valid, independently of whether it is true or false.
Fiscal policy and private consumption behaviour: The Spanish case 119

The econometric specifications of empirical studies aimed at testing the

validity of the REH fall into two broad categories10: those deriving from life
cycle-permanent income models and those obtained from Euler equations.
While the latter are also based on life cycle-permanent income models, instead
of specifying the consumption functions directly, they test the REH using the
first-order conditions that derive from the optimization process.

2.1. Structural consumption functions

The most general (because it places no implicit restrictions on the effects of

taxes, transfer payments or government purchases on consumer spending as
the life-cycle consumption functions do) and perhaps the most widely used
structural specification is that deriving from the Augmented Consolidated
Approach put forward by Kormendi (1983). He criticizes in depth the stan-
dard attitudes to modeling private consumption-saving behaviour associated
with life cycle theories, arguing that such approaches impose perceptions of
the private sector that are too ‘myopic’ with respect to the effects of gov-
ernment debt on future taxes. He proposed this generalized consumption
function11:
CPt ¼ b0 þb1 Yt þb2 Wt þb3 GPt þb4 IPt þb5 TRnt þb6 GINTt þb7 REt þb8 Dt þet
ð1Þ
where Y is the total income, W private wealth net of government debt, GP
public expenditure, IP taxes, TRn ¼ TR
GINT government transfers to
families net of interest payments, GINT government expenditure for the
payment of interest on public debt, RE retained earnings, and D the level of
public debt. In this specification the b parameters are the proof to discrimi-
nate between the Keynesian approach and the consolidated approach and its
hypothesis derived of Ricardian equivalence (see Table 1).
While structural consumption function based tests of the REH have been
the most frequently used, in the way they are conceived they present a great
degree of incompatibility with the customary models of consumption (Asc-
hauer 1985; Hayashi 1987). This is fundamentally due to the lack of an
explicit theoretical structure to generate the estimated empirical models since
all the specifications are based on ad hoc reduced forms (Miller and Roberds
1989). These tests should have as a support an approach that takes into
account the theoretical difficulties that the structural perspective has to
confront. Indeed, as Flavin (1987) points out, the structural consumption
functions are derived from a nonrational expectations approach and therefore
are inconsistent with the REH.

10
There is a third group that we might call the structural-VAR approach, aimed at discriminating
empirically between Ricardian and Keynesian behaviour. This approach allows one to distinguish
between permanent and transitory shocks of the key variables in analysing the validity of the
REH and to impose short- and/or long-term identification constraints.
11
The purpose of the proposed specification is to present the model’s basic variables, but in the
literature variables have been added, disaggregated, or modified in response to the criticisms and
counter-criticisms leveled at Kormendi’s original version (Feldstein 1982; Barth et al. 1986;
Modigliani and Sterling 1986, 1990; Feldstein and Elmendorf 1990; Kormendi and Meguire 1986,
1990, 1995; Graham 1995; Meguire 1998; etc.).
120 A. Garcı́a, J. Ramajo

Table 1. Specifications derived from Kormendi’s consumption function

Coefficient value Specification

b3 ¼ 0 b4 < 0 b5 > 0 CPt ¼ b0 þ b1 Yt þ b2 Wt þ b4 IPt weak Keynesian
b6 > 0 b7 < 0 b8 > 0 þ b5 TRnt þ b6 GINTt
þ b7 REt þ b8 Dt þ et
b1 ¼
b4 ¼ b5 ¼ b6 ¼
b7 CPt ¼ b0 þ b1 RDt þ b2 At þ e12
t strong Keynesian
b3 ¼ 0 b2 ¼ b8
b3 < 0 b4 ¼ b6 ¼ b7 ¼ b8 ¼ 0 CPt ¼ b0 þ b1 Yt þ b2 Wt weak Ricardian
þ b3 GPt þ b5 TRnt þ et
b4 ¼ b6 ¼ b7 ¼ b8 ¼ 0 CPt ¼b0 þ b1 ðYt
GPt Þ strong Ricardian
b3 < 0 b1 ¼
b3 þ b2 Wt þ b5 TRnt þ et

2.2. Euler equations

The Euler equation approach uses the first-order conditions obtained from
the optimization problem that individuals are confronted with and thus has
the advantage of being based explicitly on the inter-temporal maximization
problem, and it also allows direct tests against reality of the possible sources
of deviation of the REH (such as the hypotheses of finite horizon planning or
of the existence of liquidity constraints). On the negative side, the method has
the disadvantage of generally imposing very restrictive conditions in order to
arrive at equations that can be estimated in terms of observable variables (see
Note 3).
Aschauer (1985) gives one of the most rigorous formulations for exam-
ining the REH using the Euler approach. The model is based on the inter-
temporal optimization of the "effective consumption" of a representative
agent, which is defined as Ct ¼ CPt þ hGPt . According to this definition, a
unit of public services and goods has the same utility as h units of private
consumption, and h therefore measures the degree of substitution between CP
and GP . Assuming a quadratic utility function, and substituting into the
Euler equations, it leads to the following two-equation system:
CPt ¼ d þ bCPt
1 þ gðLÞGPt
1 þ lðLÞDPt
1 þ et
GPt ¼ c þ eðLÞGPt
1 þ xðLÞDPt
1 þ vt ð2Þ
where eðLÞ and xðLÞ are polynomials in the lag operator L of orders n and m,
respectively, and DP represents the government’s net per capita deficit.
The theoretical structure of the rational expectations approach that is used
imposes the following set of cross-equation restrictions:
d ¼ a
hc


hðb
ei Þi ¼ 1
gi ¼

hei i ¼ 2; 3; . . . ; n
lj ¼
hxj j ¼ 1; 2; . . . ; m

12
RD=Y
IP
RE + TRn + GINT is the disposable income, and A = W + D is the total
Wealth.
Fiscal policy and private consumption behaviour: The Spanish case 121

If these restrictions are not valid, then the public deficit has an impact on
private consumption that differs from the impact resulting from the predic-
tion equation (wealth effect), and the proposition of Ricardian equivalence
will not be valid. On the contrary, if on estimating the system (2) the
restrictions cannot be rejected by the data, there will exist empirical evidence
that the joint hypothesis of rational expectations/Ricardian equivalence
provides a valid approximate description of reality.
In spite of his rigour, as Graham and Himarios (1991) point out, Asc-
hauer’s model suffers of two problems. First, it fails to nest the alternative
non Ricardian hypothesis in its specification of the consumption function.
Second, Aschauer’s model relies on quadratic utility and this assumption
implies that consumption follows a first-order autoregressive process; if
quadratic utility is not a good approximation, then so is the AR(1) implica-
tion. These problems can reduce the statistical power of Aschauer’s test.
Another important group of empirical studies that has used the Euler
approach is based on the inter-temporal model of consumption proposed by
Blanchard (1985). This model includes both the REH and the non-Ricardian
case via a parameter that was originally interpreted as each individual’s
probability (p) of dying at a certain moment in time. It has a more satisfactory
interpretation in our case: it is a measure of the degree of disconnection
between generations (Evans 1993), the probability that the current members
of a family leave their descendents no inheritance (Blanchard 1985), or the
degree of short-sightedness of consumers with respect to future taxation
(Brunila 1997).
Depending on the value of the parameter p, the behaviour of the family
will be very different. If the parameter p is zero, successive generations of the
family behave in a continuous manner and therefore exhibit Ricardian
behaviour. On the contrary, if p is positive, the expected lifetime of the
household is finite and it considers government debt as net wealth.
Some examples of specifications that are deduced from Blanchard’s model
are those of Evans (1988), Himarios (1995) and Haug (1996).13
Evans starts from the following consumption function that is derived from
the first-order conditions associated with that model
" #
X1  
1
p j l
CPt ¼ a ð1 þ rÞAt
1 þ Et Ytþj ð3Þ
j¼0
1þr

where a is the marginal propensity to consume with respect to total wealth,

A ¼ W þ D represents total wealth, r is the constant real rate of interest and
Y l is the real after-tax labor income. Completing the above function with the
aggregate budgetary constraint, At ¼ ð1 þ rÞAt
1 þ Ytl
CPt , and after elim-
inating human wealth from the above system, we obtain the consumption
function showed in Table 2. The key parameter used is p, and the test of the
REH will consist of determining whether this parameter is significantly
different from zero. An important question to remark is that the Evans’s

13
Naturally, it is not our intention that this summary of the models should be exhaustive, but
that they should be representative of the most commonly used specifications in the Euler equation
approach. In this regard, there stands out the work of Brunila (1997) which can be regarded as an
extension of many of the cited studies.
122 A. Garcı́a, J. Ramajo

model is not affected by the two problems above mentioned for the Asc-
hauer’s model.
Himarios (1995) modifies the above model to incorporate the possibility of
there being a percentage (k) of families that are subject to liquidity constraints
(Campbell and Mankiw 1990). In this case of imperfect capital markets, the
solution to Blanchard’s model will be given by the function that appears in
Table 2. In this broadened context, the REH may cease to be fulfilled not
only because p > 0 (finite horizon), but also because of the existence of
liquidity constraints (1 > k > 0Þ.
Finally, let us conclude this subsection by formulating the specification that
is derived from the work of Haug (1996). Starting from the same consumption
function (3) derived from Euler’s equations14, and adding to it the government
and family budgetary constraints, Haug arrives at the cointegration regression
showed in Table 2. This equation represents the testable implication of Blan-
chard’s model. Again in this case the key parameter is p, the parameter that
measures the life horizon, and the test of the REH will consist of determining
whether this parameter is significantly different from zero.

2.3. Empirical evidence

At the international level, empirical work has not been conclusive in inves-
tigating the validity of the REH. There is at least as large a body of evidence
in favour of Ricardian equivalence as against it. See, for an extensive survey
on empirical studies, the articles of Barro (1989), Berheim (1987), Elmendorf
and Mankiw (1998), Leiderman y Blejer (1988) or Seater (1993).
The evidence for the Spanish case has not only been sparse, but also
contradictory. The most representative studies that specifically analyse the
REH are those of Argimón (1996), Fuster (1993), Marchante (1993), Ray-

Table 2. Specifications derived from Blanchard’s model

Specification Test of Ricardian eq.

15
Evans (1988)
  
1þr 1þr
CPt ¼ 1
p ð1
aÞCPt
1
ap 1
p At
1 þ aut p > 0 (finite horizon)
Himarios
 (1995)
  
1þr 1þr p > 0 (finite horizon)
CPt ¼ ð1
aÞCPt
1
ap At
1
1
p 1
p 1>k>0
  (liquidity constraints)
1þr
þ kYtl
k l
ð1
aÞYt
1 þ ut
1
p
Haug
 (1996)   
Wt
ðYt
GPt Þ
log Yt CP t Dt a

GPt ¼ d þ p Yt
GPt þ 1
a CPt þ ut p 6¼ 0

14
He disaggregates, however, the total stock of assets, A, into private (W) and governmental (D),
and the net salary income, Yl , into pre-tax (Y) and real taxes paid net of transfers to families (I).
Also, the proposed version of the model allows for the real interest rate to be variable in time
which is an important generalization with respect to most studies carried out with this approach.
15
Mathematically equivalent representations are arrived in the works of Hayashi (1982) and
Haque (1988).
Fiscal policy and private consumption behaviour: The Spanish case 123

mond (1995), and Raymond and González-Páramo (1987). There is also an

interesting study by Esteve et al. (1997) which, although it does not examine
the REH directly, analyses whether there exists a significant relationship (of
substitutability or complementarity) between public expenditure and private
consumption.
The above studies take different approaches to the topic, using data from
Spain and other EU countries. Their findings tend, in general, to reject the
REH on the basis of evidence which, while unclear in some cases, does seem
to incline towards traditional specifications of private consumption in detri-
ment of the Ricardian equivalence model.

3. The effects of fiscal policy on consumption: Spanish evidence

In this empirical section we shall estimate the econometric specifications de-

scribed in the previous section using aggregate annual data for Spain covering
the years 1955 to 2000. The Data appendix provides a brief description of
data sources and variables, as well as summary statistics.

3.1. Stationarity of the variables

Since the regressions to be performed are based on time series, we shall first
analyse the order of integrability of the variables so as to avoid possible
spurious regressions between them (Stock and Watson 1988; Nelson and
Plosser 1982). To this end, we shall use the ADF (Dickey and Fuller 1979,
1981) and PP (Phillips and Perron 1988) tests, whose null hypothesis is that
the variable being analysed has a unit root. The results of these tests are given
in Table A.1 of the Data appendix. The application of the ADF and PP tests
for the twelve variables under analysis indicated that, except for a single case
(this one being at a 10% significance level), the null hypothesis of the exis-
tence of a unit root can not be rejected, while in all the cases the presence of a
second unit root was rejected at the standard significance levels. The series
analysed in the present work can therefore be regarded as behaving as I(1)
variables over the period considered.

3.2. Estimation of the different econometric specifications

Although we recognize all the limitations of the estimates coming from

structural specifications, we shall begin by analysing the consumption func-
tion proposed by Kormendi because we think these estimates can be infor-
mative about the order of magnitude and significance of the effect of the
different fiscal variables on aggregate consumption.16
Instead of making an OLS estimation of the specification Eq. (1), given
the stationarity results of the previous subsection, we shall first perform a

16
We follow Feldstein’s suggestion ‘‘…As economists, we must learn about the world by
examining a variety of estimates, each with its own biases and measurement problems, and trying
to draw inferences that take theses problems into account’’ (Feldstein 1996, p. 162).
124 A. Garcı́a, J. Ramajo

cointegration analysis and then proceed to estimate the possible long- and/or
short-term relationships.
This explicit separation of the long and short terms has a twofold objec-
tive. On the one hand, at a technical level, we shall make use of the appro-
priate method of analysing relationships between non-stationary variables.
On the other hand, from an economic perspective, we shall analyse the dif-
ferences that arise in the fulfillment or otherwise of the REH in the different
temporal horizons. In particular, it will be possible to uncover evidence in
support of the hypothesis of Deaton (1992) that the validity of the REH in the
long term could be affected by the behaviour of the credit market for that
temporal horizon, or, on the contrary, of the hypothesis of Seater (1985) that,
if valid, the REH should be expected to be a long-term phenomenon since
problems of incomplete information can give rise to consumer short-sight-
edness in the short term.
Given the small number of observations (46 years) and the great number
of variables involved in the Kormendi specification, we decided to use dif-
ferent econometric approaches (in both testing and estimating) so as to obtain
results that are ‘‘robust’’ with respect to which perspective is adopted. In
particular, to test and estimate the possible cointegration relationships, we
used the ARDL approach of Pesaran and Shin (1999) and Pesaran et al.
(2001), and the methods of Johansen (1991) and Phillips-Hansen (1990).
The variables involved in the Kormendi function are (using the nomen-
clature of the Data Appendix and REB as undistributed company profits)
CP, Y, W, GP, IP, TRn, GINT, REB, and D. Utilizing the bounds test
proposed by Pesaran et al. (2001) in its F-form, and an order-one ARDL
model as support, we obtained the value F = 6.35. The critical values of
this test for K = 8 (the number of explanatory variables) are
C0K ¼ 2:27 and C1K ¼ 3:45 at 95%, and C0K ¼ 2:85 and C1K ¼ 4:13 at 99%. The
null hypothesis of no cointegration can therefore be rejected at 99%.17 Using
the net business saving variable (REN) instead of the gross variable gave the
value F = 5.44 for the F-statistic, thus also rejecting the null hypothesis of the
absence of cointegration.
In estimating the cointegration regression, we decided to use as the ref-
erence econometric framework the ARDL approach of Pesaran and Shin
(1999), since this is based on a single-equation dynamic formulation that
includes the type of specification used for the consumption function in studies
of the Spanish economy by Raymond and González-Páramo (1987) and
Marchante (1993). It therefore allows our results to be directly compared with
those of the earlier studies. We also used, however, the methods of Johansen
and Phillips-Hansen to confirm the estimates and conclusions obtained.18
We first used a general first-order ARDL model for the nine variables of
the Kormendi function, simplifying it on the basis of the usual information
criteria (Akaike, Schwarz and Hannan-Quinn). All the criteria led to the

17
Using Johansen’s approach, under the hypothesis of the existence of stochastic trends in the
series and a VAR(1) model as support for the test, both the trace and the maximum eigenvalue
tests indicated the existence of one (and only one) cointegration relationship, both at the 1% level.
18
Detailed information on all the intermediate and complementary results in the estimates
presented here are available upon request from the authors.
Fiscal policy and private consumption behaviour: The Spanish case 125

Table 3. Estimation of Kormendi’s consumption function

Variable Y W GP IP TRn GINT REB/ D ecm(-1)

effect REN
Long 0.631 0.026 )0.591 )0.189 0.722 0.226 )0.165 0.013
term (9.19) (1.34) ()2.54) ()1.60) (2.91) (1.06) ()2.60) (0.43)
0.551 0.049 )0.433 )0.054 0.276 0.257 )0.174 )0.030
(9.12) (2.99) ()1.88) ()0.55) (1.75) (0.95) ()1.32) ()1.16)
Short 0.544 )0.028 )0.275 )0.239 0.666 )0.335 0.084 )0.048 )0.885
term (6.16) ()0.92) ()0.96) ()1.63) (2.86) ()0.94) (0.94) ()1.09) ()6.27)
0.498 )0.035 )0.342 )0.153 0.406 )0.420 0.173 )0.022 )0.883
(5.91) ()1.23) ()0.94) ()1.05) (1.81) ()0.97) (0.88) ()0.50) ()5.91)

model ARDL(0,0,1,1,1,0,0,1,1), which was used to calculate the long- and

short-term estimates given in the second and fourth rows of Table 3.19
In the long-run one notes the significance of public expenditure which has
a negative influence on private consumption, reflecting the importance of the
crowding-out effect between private and public spending, and also the lack of
significance of the variables public revenue, interest on public debt, and
volume of government debt, as would be expected according to the Ricardian
equivalence hypothesis. On the other hand, similar to the findings of
Marchante’s study (Marchante 1993), gross retained earnings have a signifi-
cant negative effect on consumption (households deem corporate saving as a
substitute for personal saving; Feldstein 1973). Finally, the value of the
marginal propensity to transfer was notably high (and highly significant),
reflecting the major impact on private consumption of this variable which is
associated with the phenomenon of income redistribution.
As was noted in Sect. 2, both the Keynesian and the Ricardian models are
special cases of the general Kormendi specification (see Table 1). For the long
term, the formal test of the Keynesian and Ricardian hypotheses in their weak
forms gave Wald statistics and their associated P-values of W = 6.47 (P =
0.011) and W = 11.12 (P = 0.025)20, respectively, so that the data reject both
postulates for the long term.
We also considered the possibility of using as a variable representative of
the amount of undistributed company profits the net retained earnings, REN,
instead of the gross saving. The third row of Table 3 gives the long-term
results for this case after the simplification of the general first-order ARDL
model to the ARDL(0,0,1,0,1,0,0,1,0) model finally selected.
One sees that, while the results are qualitatively similar to those obtained
using the gross business saving variable, quantitatively the estimates differ
notably, especially for private wealth (W), net transfers (TRn), and in the

19
We repeated all the calculations estimating the Kormendi consumption function using
logarithms of the data to test the robustness of the results under such a transformation. There
were few changes and the results basically coincided with those obtained without the
transformation.
20
The rejection of the weak equivalence hypothesis is due to the significance of the variable REB
since the data did not reject the conjoint hypothesis of nullity of the parameters associated with
the variables IP, GIN, and D.
126 A. Garcı́a, J. Ramajo

significance of the saving variable (REN). There is again a significant negative

effect of public expenditure on consumption, invalidating even the weakest
hypothesis of Keynesian behaviour. Instead, the estimates for the parameters
b3 ; b4 ; b6 ; b7 and b8 are now more in line with the Ricardian postulates. In-
deed, the formal test of the Ricardian equivalence hypothesis gave a value of
W = 7.56 with an associated P-value of P = 0.11, so that the hypothesis can
not be rejected, at least marginally.
In sum, with Kormendi’s consolidated approach, for the long term the
direct evidence from variables measuring debt and/or deficits supports
REH.21 In that case, however, it is hard to explain some of the other coef-
ficients, such as the effect of corporate retained earnings. If households are
smart enough to discount future taxes, as the direct evidence suggests, why do
they react to retained earnings the way the results indicate they do?
With respect to the short term, the last two rows of Table 3 give the
estimates obtained after finding the ECM model associated with the ARDL
specifications that were used. In both cases, the estimates were made by the
method of instrumental variables in order to correct the possible endogeneity
of some of the regressors (we use as instruments the constant, the error
correction term, and the second and third lags of the explanatory variables).
One sees that the results differ substantially from those obtained for the long-
term equation. In neither version was the parameter for public expenditure
statistically significant (W = 0.92, P = 0.34; W = 0.88, P = 0.35), nor was
the hypothesis of nullity of the coefficients associated with the variables IP,
GINT, RE(B/N) and D rejected (W = 9.40, P = 0.05; W = 2.81, P = 0.59),
although it was on the borderline of rejection in the first equation.22 The
evidence in this case is therefore mixed, with respect to both the Keynesian
and Ricardian views.
As was noted above, there is an indication in Deaton (1992) of a possible
theoretical explanation of the differential behaviour of the REH in the short
and long terms: the differential behaviour of the credit market according to
the temporal horizon. Thus, when individuals plan their optimal consump-
tion, they might find their temporal horizon cut short due to the impossibility
of obtaining loans for long-term consumption. On the contrary, such rational
and far-sighted behaviour does not face the same limitations when one con-
siders the short term.
After these estimates of the structural specification, we shall now consider
the estimation of different formulations associated with the Euler approach.
In all cases we opted to use the generalized method of moments (GMM) for
the estimation procedure, since this is the method best suited to estimating
equations that derive directly from the first-order conditions associated with
problems of inter-temporal optimization (Favero 2001).
Before proceeding to the estimation of Aschauer’s model (Eq. 2), we first
tested the cointegration of the variables that appear in each equation. Since
not too many variables were involved in this case, we used the customary

21
Hence, there exists evidence in support of the hypothesis of Seater that the Ricardian
proposition is valid in the long term: ‘‘…government debt will have no effects on the state in the
long run, although it will have short-run effects before full tax perception occurs’’ (Seater 1985, p.
124).
22
Individually, however, none of the variables was significant even at the 10% level.
Fiscal policy and private consumption behaviour: The Spanish case 127

Table 4. Estimation of Aschauer’s model

Unrestricted model Restricted model

a=12.112 (0.87) d=38.514 (4.08)
b=1.014 (28.26) b=0.937 (33.35)
g1 =1.068 (1.93) h=)2.171 ()8.31)
g2 =)1.120 ()1.82)
l1 =)0.666 ()3.42)
l2 =0.806 (4.24)
c=2.253 (1.63) c=3.744 (3.23)
e1 =1.789 (6.63) e1 =1.735 (10.31)
e2 =)0.791 ()2.72) e2 =)0.750 ()4.11)
x1 =)0.276 ()2.88) x1 =)0.301 ()3.74)
x2 =0.280 (8.35) x2 =0.343 (11.39)

Johansen test.23 For the first equation, with the variables CP, GP, and DP,
both the trace (ktrace ¼ 30:76) and the maximum eigenvalue (kmax ¼ 26:76)
tests indicated the presence of only a single cointegration relationship (at 1%)
between these variables. For the second equation, with the variables GP and
DP, the result was the same (ktrace ¼ 20:13, kmax ¼ 19:17), so that we then
proceeded to the conjoint estimation of Aschauer’s system with the variables
in levels. After carrying out the opportune tests, we finally concluded that two
lags in the polynomials eðLÞ and xðLÞ were sufficient to adequately describe
the evolution of the government expenditure variable, GP. The final estimated
system was the following:

CPt ¼ a þ bCPt
1 þ g1 GPt
1 þ g2 GPt
2 þ l1 DPt
1 þ l2 DPt
2 þ et

GPt ¼ c þ e1 GPt
1 þ e2 GPt
2 þ x1 DPt
1 þ x2 DPt
2 þ vt

Table 4 gives the results of the free estimation of the above system by GMM,
using a constant and the second and third lags of the variables CP, GP, and
DP as instruments. The table also gives the results of the constrained esti-
mation.24
One sees that the free and the constrained values are very similar. Indeed,
the conjoint test of the hypotheses of rational expectations/Ricardian
equivalence gave a value of W = 0.004 with an associated P-value of P =
0.99. The constraints are therefore not rejected, and the data are consistent
with rational behaviour and Ricardian equivalence.
Besides providing a means of testing the REH, Aschauer’s model allows
for a quantification of the degree of complementarity/substitutibility in the
relationship between private and public consumption. The conclusion in view
of the value of the parameter obtained in estimating the model h^ ¼
2:171,
which was significant at the 1% level and below, is that private and gov-
ernment consumption can be considered as complementary. Whereas these

23
Nevertheless, as with the previous models, we completed the cointegration analysis with other
complementary methods, in this case with the Pesaran-Shin-Smith bounds test. In all cases the
result was the same as with the Johansen approach.
24
In all cases where GMM was used, we tested the over-identifying restrictions of the model
using the J-test of Hansen (1982).
128 A. Garcı́a, J. Ramajo

Table 5. Estimation of Campbell and Mankiw’s model

DCP DGP DRD Constant

1 )2.027 ()3.76) 2.779 (0.49)
1 0.357 (2.32) 0.577 (7.02) 8.075 (5.27)

results are in clear agreement with those of Karras (1994) for a sample of
thirty countries (see also the work of Kuehlwein 1998 and Ni 1995), they are
in clear disagreement with the ones that we obtained from Kormendi’s
function (for both the short and the long term). In the following lines we shall
attempt to explain this discrepancy, using arguments similar to those used by
Graham (1993) to explain the instability of estimates of Aschauer’s model for
the US case.
Firstly, we performed a cointegration analysis between the variables CP
and GP on the one hand, and CP, GP, and RD on the other [real per capita
disposable income was included because of the possible existence of liquidity
constraints (Campbell and Mankiw 1990)]. In both cases, and under all the
possible hypotheses with respect to the cataloguing of the series’ stochastic
properties, the null hypothesis of the absence of cointegration between the
variables could not be rejected. It can therefore be concluded that there exists
no stable long-term relationship between them, and there only remains the
issue of their short-term relationship.
We then estimated Eq. (4)
DCPt ¼ a
hDGPt þ et ð4Þ
which results from imposing the constraint b ¼ 1 on Aschauer’s model. As it
can be deduced from the results given in Table 4, this hypothesis seems to be
verified empirically in our case (the formal test of the hypothesis gave W =
0.11 [P = 0.74] and W = 1.21 [P = 0.27] in the free and restricted versions,
respectively), so that the results of the estimate of Eq. (4) are similar to those
obtained with the two-equation model (2).
The values of the first row of Table 5 from the GMM estimation of Eq. (4)
using as instruments the variables GPt-i, DPt-i, with i = 1, 2 (those used to
forecast future values of government expenditure) give a value for the
parameter h that is similar to that obtained before, and one does not reject
(P = 0.524) the corresponding test of the overidentification constraints
(analogous to the crossed restrictions of Aschauer’s model). This indicates
that ‘‘the problem’’ in the estimate of the substitution parameter does not lie
with the estimation method.
As noted by Graham (1993), the estimates of Aschauer’s model are subject
to a considerable level of fragility. One of the reasons is that the model does
not include disposable income. This variable therefore has to be incorporated
into a respecification of the model Eq. (4), so that the equation to estimate
will be of the following type (see Graham 1993 or Karras 1994):
DCPt ¼ a
hDGPt þ kDRDt þ et ð5Þ
where Et
2 ½et  ¼ 0. Setting the parameter k equal to zero when it really is
significant could lead to a major bias in the estimate of h, which would
explain the abnormal value found in estimating Aschauer’s model with our
data.
Fiscal policy and private consumption behaviour: The Spanish case 129

Table 6. Estimation of Evans and Himarios’s models

CP CP()1) A()1) RD RD()1)

1 1.047 (69.43) )0.002 ()0.63)
1 0.974 (11.23) )0.001 ()0.67) 0.669 (6.83) )0.638 ()8.47)

We estimated Eq. (5) using the GMM method with, as instruments, a

constant and the variables CP, GP, RD, and DP lagged by two and three
periods (these are the same instruments as in Karras’s international analy-
sis).25 The results are given in the second row of Table 5.
One sees that there are substantial differences between the estimates given
by Eqs. (4) and (5). Firstly, the data clearly reject the constraint k ¼ 0 (W =
49.22, P = 0.00). Secondly, the estimate of the parameter h changed radically,
both in sign and in magnitude, with respect to the previous result. The value
obtained h^ ¼ 0:357 is highly significant (W = 5.37, P = 0.02) and confirms
the results from Kormendi’s model, again indicating the substitutibility re-
lationship between private and government consumption. In both cases, the
values are similar to those estimated by Kormendi and Aschauer (between
0.23 and 0.42) for the US case, and, given that they are relatively low (far
from unity), they suggest that a temporal increment in government expen-
diture may have a certain effectiveness in raising the level of real production.26
Also, the model (5) provides an estimate of the effect of income on private
consumption, quantified in the present case at k^ ¼ 0:577. This value could
also be interpreted as the fraction of income that is subject to liquidity
constraints [it is spent by individuals who consume all their contemporaneous
income (Campbell and Mankiw 1990)].
As was noted in Sect. 2, there have been many studies that have used the
Euler approach starting from the consumption model of Blanchard (1985),
with the one by Evans (1988) being of especial interest.
Table 6 gives the results of the GMM estimation of the equations derived
by Evans27 both including and excluding the possibility of there existing
liquidity constraints. (As in the previous cases, apart from the constant, the
instruments were the model’s variables lagged by two and three periods).
With respect to the basic equation (Evans’s model), the null hypothesis of
infinite planning horizon is not rejected since the parameter associated with
the lagged total wealth variable A(-1) is not significant (W = 0.39, P = 0.53)
and there is thus no evidence against the REH. In the extended version
(Himarios’s model), however, while the hypothesis that p = 0 is not rejected
(W = 0.46, P = 0.50), rejection is clear for the hypothesis of absence of
significance of the parameters associated with the variables RD and RD(-1)

25
We repeated the calculations using different sets of instruments, in particular those used by
Graham (1993) in replying to the work of Aschauer (1985). In all cases the results were very
similar to those given in Table 5.
26
The smaller the value of h, the greater will be the increase in public consumption (Hall 1980;
Barro 1981).
27
Prior to the estimation procedure, we carried out a cointegration analysis, concluding that (in
this case at the 95% confidence level) there exists just a single cointegration relationship between
the variables involved in the model.
130 A. Garcı́a, J. Ramajo

Table 7. Estimation of Haug’s model

log[CP/(Y-GP)] D/(Y-GP) (W-Y+GP)/CP Constant

1 0.051 (1.20) 0.012 (0.85) )0.179 ()6.44)

(W = 72.45, P = 0.00), pointing to the existence of liquidity constraints.

Also, the coefficient of disposable contemporaneous income, k^ ¼ 0:669, again
indicates the proportion of income subject to these constraints, has a value
similar to that found with the model of competition/complementarity anal-
ysed in the previous paragraphs. In sum, the results suggest that the source of
deviation from the REH is not consumers’ ‘‘short-sightedness’’ but the
existence of an imperfect capital market in that a major proportion of families
are subject to liquidity constraints.
Finally, to conclude with our estimations of the Euler equations, Table 7
gives our results for the model formulated by Haug (1996). 28
The Wald test of the significance of the life-horizon parameter p gave the
value W = 1.45 with an associated P-value of P = 0.229 and therefore it is
not significantly different from 0. Hence again, the hypothesis of an infinite
planning horizon can not be rejected. And, if households behave as if they live
forever, Ricardian equivalence holds in Blanchard’s model and the govern-
ment debt does not influence consumption.

Conclusions

The aim of this article was to present empirical evidence for the Spanish case
on the question of whether fiscal policies have any impact on consumer
behaviour. Our objective has been for the present estimations to be exhaustive
in the sense of testing the REH under different specifications and approaches,
both theoretically and econometrically. We have estimated a Kormendi-type
consumption function and several Blanchard-type models of consumption. In
all cases, before we estimated any multiple time-series regression, we had
checked that all variables were cointegrated and in testing the cointegration
hypothesis we used both Pesaran and Shin and Johansen approaches.
We can deduce from our estimations that, in the case of Spain, neither of
the two theoretical perspectives on how fiscal policy affects private con-
sumption reliably fits the data for the period 1955–2000. There is, however,
evidence that the partial neutrality hypothesis fits Spanish reality, and in any
event the tests generally showed a clear rejection of the standard versions
derived from the Keynesian approach to consumption. These findings are, in
general, contrary to previous results reported in the Spanish literature. The
reason for these differences may be the application of more appropriate
econometric techniques than were used in those earlier studies and in the
analysis of much longer time series.

28
As in previous cases, we first tested for the existence of cointegration. The Johansen test clearly
indicated (at 1%) the presence of just a single cointegration relationship between the variables
log[CP/(Y-GP)], D/(Y-GP), and (W-Y+GP)/CP. For the GMM estimation, apart from the
constant, we used the second and third lags of the variables D, W, Y, and GP.
Fiscal policy and private consumption behaviour: The Spanish case 131

The results indicate different sources of deviation from the full Ricardian
equivalence, basically in the significance of the estimated effects of the vari-
ables business saving (as gross saving only) and contemporaneous income.
This shows the presence of substitution effects between business and family
saving, and the existence of liquidity constraints that prevent some consumers
from free access to capital markets.
We also observed certain contradictory evidence for the REH in the short
and long term which could be associated with the differential behaviour of the
financial market according to the duration of credits, and therefore with the
influence of liquidity constraints in limiting consumers’ temporal horizon.
Finally, we found the presence of a significant crowding-out effect,
reflecting a degree of substitutibility between public and private consumption.

Data appendix

This appendix describes the data series and the sources used to construct the
variables. The sample contains annual data from the Spanish economy cov-
ering the period 1955–2000. All the data were expressed in real (1995=100)
and per capita terms.29 The consumption expenditure implicit price deflator
was used to deflate all the series, except for the private capital stock, where its
specific deflator was used. This method is the same that Kormendi (1983) uses
and it is now generally accepted in the literature.30 Furthermore, in our case it
is impossible to use specific deflators for the other variables because they are
not available in Spanish statistics.
The series were built by using the longest available series. As far as pos-
sible we have employed the data series published by the Bank of Spain.
However, for the first years of data, we used the historical series from the
studies of the Spanish economy made by Comı́n (1985) and Corrales and
Taguas (1989). Other basic sources were the different statistics from the
publications and reports of the Fundación Banco Bilbao Vizcaya (BBV) or
Banco Bilbao Vizcaya Argentaria (BBVA). Other sources were also consulted
to complete the time-series: different volumes of Spain’s National Accounts
(Contabilidad Nacional de España) elaborated by the National Institute of
Statistics (INE) of Spain; the publication of the Fundación BBV (Uriel et al.,
2000), that presents linked national accounting for Spain covering the period
1954–1997; various issues of the Institute for Fiscal Studies of Spain on the
accounts of the Public Administrations sector; the study of this same sector

29
Meguire (1998) points out that heteroskedasticity is a common problem when using time-series
data that are not transformed (logged o weighted). However, our data are expressed in per capita
terms, which implicitly weights the observations by the inverse of the population and may control
for heteroskecasticity.
30
This method is subject to controversy because the use of different deflators can affect results.
Kormendi and Meguire (1990), in replying to Feldstein and Elmendorf’s (1990) criticism of
Kormendi (1983), showed that results are sensitive to the use of the wrong deflator.
132 A. Garcı́a, J. Ramajo

by Argimón et al. (1999), and finally, the data published in the Appendix of
Raymond and González-Páramo (1987).
In the following lines, a description of variables, data sources and some
variable computations is offered:31
– CP: Private consumption. Statistical sources: Corrales and Taguas
(1989) and BBV.
– Y: Gross available income (before taxes and transfers). Statistical
sources: Corrales and Taguas (1989) and BBV.
– IP: Total public revenues. Statistical sources: Corrales and Taguas
(1989), Comı́n (1985) and BBV.
– TR: Total transfer payments. Statistical sources: Corrales and Taguas
(1989), Comı́n (1985) and BBV.
– RD: Net real per capita disposable income. This variable was calculated
using Y, IP, RE and TR.
– GP: Total government expenditures (includes consumption of goods and
services and gross capital formation). Statistical sources: Corrales
and Taguas (1989), Comı́n (1985) and BBV.
– DP: Deficit of Public Administrations. This variable was calculated using
IP, TR and GP.
– REB: Gross business saving. Statistical sources: Corrales and Taguas
(1989), BBV, Bank of Spain and author’s estimations. It was very
difficult to obtain this variable, as well as the Net business saving
variable, for the Spanish economy. These series were built by using
the longest disposable series. For the last years of data (1988–2000),
different variables from the statistics of the Bank of Spain were used.
From 1955 to 1964 the variable was calculated using an index made
with information about firms’ profit from BBV.
– REN: Net business saving. Statistical sources: Corrales and Taguas (1989),
BBV, Bank of Spain and author’s estimations from the gross busi-
ness savinǵs variable.
– D: Government debt. Statistical sources: Comı́n (1985), Corrales and
Taguas (1989), BBV and Bank of Spain.
– GINT: Interest payments on debt. Statistical sources: Comı́n (1985), Cor-
rales and Taguas (1989), BBV and Bank of Spain.
– W: Private wealth (stock of private productive capital plus liquid assets
held by the public). The liquid assets held by the public (ALP) were
calculated using different definitions from the Bank of Spain. The
first data sample includes the years 1955–1983. In 1984 the series
were redefined and it was necessary to link the data eliminating the
public debt. In 1991, another change in the variable definition forced
us to create a new link in the data. Statistical sources: Corrales and
Taguas (1989), BBV (Mas et al. 1998), Bank of Spain and author’s
estimations.
– WT: Total wealth. This variable was calculated using W and D.

31
More extensive explanations about the sources used and the methodology employed to
construct the series are available upon request from the authors. Time series are also available for
interested researchers.
Fiscal policy and private consumption behaviour: The Spanish case 133

Table A1. Variable definitions and unit root tests

Variable ADF test PP test

(levels/first.dif.) (levels/first.dif.)
CP Private consumption )2.32 )3.30** )1.75 )3.36**
RD Net disposable income )2.32 )3.38** )1.78 )3.44**
IP Total public revenues )2.19 )3.50** )1.88 )3.59***
TR Total transfers )2.25 )5.80*** )2.23 )5.93***
GP Total government spending )2.44 )4.23*** )2.08 )4.32***
DP Deficit of Public Administrations )1.92 )5.40*** )2.04 )5.55***
Y Gross available income )3.23* )2.98** )1.98 )2.99**
REB Gross business saving )3.01 )5.27*** )3.15 )5.16***
REN Net business saving )2.53 )5.04*** )2.82 )4.94***
D Stock of public debt )1.21 )3.67*** )0.91 )3.73***
GINT Interest payments on the debt )1.80 )5.13*** )1.79 )5.24***
W Private wealth )1.61 )3.62*** )1.30 )3.57**

Notes: All the original variables have been divided by the population and deflated (1995=100).
The symbols (*), (**), and (***) represent significance levels of 10%, 5%, and 1%, respectively.

One of the limitations for this kind of empirical work is the unavailability of
suitable economic data. This is a major limitation in order to be able to carry
out the different tests that could be applied. As an example, due to the non-
availability of adequate and reliable statistics, disaggregation of key variables
such as disposable personal income, wealth, budget deficit or government
spending was not possible with the Spanish data.
Finally, Table A.1 shows the variable definitions and the values of the
ADF and PP tests carried out to asses the order of integrability of the series
used in the estimations.32

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