This paper revisits the issue of the Ricardian Equivalence Hypothesis (REH), as since its reemergence, its theoretically underlying premises have been called into question. Yet, severe criticism raised by its opponents concerning the efficacy of government actions has further challenged the need for empirical analysis. In the traditionally Keynesian approach, the majority of the research work has ignored issues pertinent to cointegration and/or the stationarity-exogeneity features of the data, thus offering rather vitiated results. In this paper, the author suggests that as long as a single cointegrating vector exists, the Phillips-Hansen OLS estimator can be safely adopted, as it is asymptotically equivalent to full-information system methods. The main result sharply contradicts conventional priors of REH, as budget deficits strongly affect the pattern of interest rates. However, any unidirectional short-run causality link between these variables has not been established. Nevertheless, rigorous testing of the model, in terms of binding restrictions occasionally introduces sensitivity in certain findings. As a policy exercise, the paper tries to identify the determinants of the long-term interest rates, crucial in this study. The evidence demonstrates a decisive role for macroeconomic policy in shaping interest rates suggesting that national, rather than the international factors or the structure of the economy per se, seem to be more important in explaining interest rates behavior in Greece.

Greece was on the Bretton Woods system of fixed exchange rate until 1972. After its breakdown, there was a crawling-peg policy for almost three years until 1975, when the monetary authorities switched to managed floating. In parallel, three major fiscal developments of structural nature occurred. First, the restoration of democracy following the military regime which prevailed from 1967 to 1974. Second, the governmental propensity towards a combination of spending sprees and deferral of taxes, due to a series of electoral cycles, led to the 1986 stabilization program with draconian income policies and severe fiscal stringency plans in order to restore public finances. Third, an attempt at gradual adjustment towards the economics of convergence with the implementation of the criteria of the European Monetary System (EMS), and the successful participation in the 2001 Euro currency area. In essence, the economic policy was based upon two axes, namely, structural reforming and macroeconomic discipline by involving, stringency in the conduction of the fiscal-monetary policy mix, in order to reverse the upward tendency of public debt, to reduce the rate of inflation at a permanent low level, and hence, to substantially improve all public finance figures.

A major issue of macroeconomic policy studies has been, unquestionably, the impact of fiscal deficits on the levels of private sector wealth and consumption. The process by which the government extracts an enormous amount of economic resources from the society, known as the absorption approach, further justifies the great interest in the effects of budgetary policies on aggregate demand. In addition, different courses of policy action affect a number of key macroeconomic variables, such as the rate of inflation, the level of unemployment, the real interest rate and the balance of payments. The early Keynesian analysis was based on the premise that fiscal policy affects aggregate demand by inducing a surge in private sector consumption, realized through a strong impact on current disposable income. However, it is now recognized that the extent of such a fiscal stimulus has been moderated due to a combination of monetary policy feedback through higher interest rates, reduced real money balances, and changes in portfolio composition and asset allocation.

Monetary Economics Journal, Governmental Budget Deficits, Ricardian Equivalence Hypothesis, Macroeconomic Policy, European Monetary System, EMS, Economic Resources, Macroeconomic Variables, Private Sector Consumption, Economic Policies, Econometric Methodology, US Economy.