level that adjusts to the future fiscal surpluses, or if it is the trajectory of fiscal surpluses
that adjusts to the price level.
In a Ricardian regime, it is assumed that government debt is not seen as wealth, and that
the public takes for granted that the government eventually will adjust its strategy to be
consistent with the transversality condition and fiscal policy sustainability. It is
nevertheless possible that in some periods, the budget surpluses do not seem adequate to
keep the debt-to-GDP ratio under acceptable limits. However, even in that
circumstance, there might not be a price level increase.
In a non-Ricardian regime it is expected that the transversality condition be met in
equilibrium, and that the stock of public debt may temporarily show values that are
inconsistent with such a condition. In this case, even if the debt-to-GDP ratio is rather
high, and if there is a wealth effect from government debt, there might be an increase of
aggregate demand resulting in the rise of the price level. The real value of the
government liabilities would then be reduced, allowing once more the formation of
favourable expectations as to the fulfilment of the transversality condition.
4.1. Budget deficits and public debt
Canzoneri, Cumby and Diba (2000) use a bivariate VAR test for the existence of a
Ricardian regime, by assessing if the primary budget surplus, as a percentage of GDP,
negatively influences the government liabilities, also as a ratio of GDP. In the
government liabilities are included both public debt and monetary base. In a regime of
monetary dominance, a Ricardian regime, the positive changes in the budget surplus
should be used to pay back some of the outstanding public debt, that is, one would
expect to see an inverse relationship between the primary budget surplus and the
government liabilities. They test a VAR model using the primary budget surplus, in real
terms, as a percentage of GDP, including seigniorage revenues and the government
liabilities, in real terms, as a percentage of GDP, including public debt and monetary
base.
In such a set-up, the hypothesis of a Ricardian regime, of monetary dominance, could
not be rejected when the increase of budget surpluses is used to cut down government
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