Empirical test of the Ricardian equivalence in the Kingdom of Lesotho

Abstract

The objective of this paper is to test the existence of Ricardian Equivalence in Lesotho using annual data for two sample periods, 1980-2014 and 1988-2014. This proposition is important and has crucial implications for tax policy. Household consumption, government debt, government expenditure, GDP per capita, population growth and inflation are variables which are used for this analysis. The study used ARDL cointegration approach to investigate the relationship between these variables. The study found that there is long run equilibrium relationship among the variables in two sample periods. The results show that an increase in government debt or government expenditure will decrease household consumption per capita. This implies that the Ricardian Equivalence does hold for Lesotho. The results also imply that fiscal policy is an ineffective tool to stabilize the economy. Lesotho has limited fiscal flexibility, and it will be difficult or challenging to increase private consumption and economic growth, particularly during economic downturn.