THE INTEREST-RATE NEUTRALITY OF FISCAL DEFICITS - TESTING FOR RICARDIAN EQUIVALENCE AND CAPITAL INFLOW

This paper examines the extent to which the Ricardian equivalence theorem as restated by Barro (1974) and the capital inflow hypothesis of Dwyer (1985) provide valid explanations of the observed interest rate neutrality of fiscal policy in open economies. A theoretical open-economy macromodel is specified and subsequently tested on a multi-country dataset which spans the recent period of floating exchange rates. On balance, the empirical results favour the capital inflow hypothesis which emphasizes the importance of international financial integration in facilitating the financing of public deficits by the savings of agents who reside across political frontiers. © 1991.