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Ricardian equivalence and positively sloped IS curve: (Dis)equilibrium insights

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  • Chrysanthopoulou, Xakousti
  • Sidiropoulos, Moise
  • Tsioutsios, Alexandros

Abstract

In the New-Keynesian model augmented with non-Ricardian households (breakdown of the Ricardian equivalence), the elasticity of aggregate demand to changes in real interest rate is linked non-linearly to the share of non-Ricardian households. Importantly, this dependence may result in an upward-sloping dynamic New-Keynesian IS curve. Using an extended fractionally cointegrated VAR model in a recursive framework, we empirically test this for the US from 1959 to 2024, finding a positive long-run relationship between consumption and interest rates from 1980 to 1992, and a negative one from 1993 onwards, with a stronger negative correlation after 2000. These results suggest shifts in asset market participation, altering equilibrium dynamics in the goods market. We analytically show that when non-Ricardian households surpass a certain threshold, output adjusts to excess supply rather than demand, imposing novel restrictions on the New-Keynesian Phillips curve to maintain equilibrium determinacy. These bounds on the New-Keynesian Phillips curve slope under varying inflation targeting rules offer a new perspective on monetary policy design.

Suggested Citation

  • Chrysanthopoulou, Xakousti & Sidiropoulos, Moise & Tsioutsios, Alexandros, 2024. "Ricardian equivalence and positively sloped IS curve: (Dis)equilibrium insights," The Journal of Economic Asymmetries, Elsevier, vol. 30(C).
    • Handle: RePEc:eee:joecas:v:30:y:2024:i:c:s1703494924000343
    DOI: 10.1016/j.jeca.2024.e00385
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    More about this item

    Keywords

    Limited asset market participation; Dynamic IS curve; Dynamic stability; Ricardian equivalence; Determinacy; FCVAR;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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