Abstract

This paper explores the relationship between government debt and private consumption for Malta. In particular, it attempts to find evidence in favor or against the proposition that the consumption behavior of Maltese households follows the Ricardian Equivalence Theorem. The empirical findings from this analysis suggest that household consumption behavior in Malta is not Ricardian. The resulting lack of evidence supporting the presence of a cointegrating relationship between private consumption and public debt indicates that there is no long run relationship amongst these two variables. However, the results obtained from a subsequent application of a vector auto regressive generalized impulse response function suggests that in the short-term a rise in public debt does positively influence private household consumption. This implies that Keynesian theory may be better suited at explaining the underlying behavior of Maltese households in response to changes in the level of public debt, supporting the view that Maltese households, on aggregate, exhibit a myopic behavior with regards to household consumption patterns. This suggests that to an extent, the Government may thus be able to take advantage of the implicit effectiveness of an expansionary fiscal stance to stimulate the economy through higher aggregate consumption, at least in the short run. However, it should be noted that in the case of Malta the non-presence of the Ricardian Equivalence Theorem may not necessarily imply a high level of effectiveness of Keynesian fiscal policy, given that Malta is a small and open economy characterized by a high level of import content in its aggregate demand components. The longer-term implications pertaining to the public debt burden on future generations should be taken into account by policy makers as higher levels of debt could result in an eventual contractionary fiscal stance, which would negatively impact the consumption pattern of future generations.

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