Experimental Study of Debt Illusion in Iranian Economy Using ARDL Approach

The key notion of debt illusion implies that the determined level of government’s revenues and the short term and long term structure of tax influence the level of government’s expenditures and debts. The concept of debt illusion is of vital significance for an important discussion of macroeconomics, i.e. examination of the effects of fiscal policies on the behaviors of private sector. Keynesian theory of macroeconomics argues that in a determined level of government’s expenditures tax reduction as a result of financing the debts increases the total demand, while according to the alternative perspective better known as Ricardian Equivalence only replaces the current tax with the equivalent amount of the current value of the future tax. Ricardians argue that debt financing and financing by tax are equivalent and thus tax reduction is insignificant. This research seeks to study the effects of budget deficit and debt on private consumption. The difference between the present study and previous similar researches lies in using debt Ricardian hypothesis as means for comparing the traditional outlook with the equivalence problem. The research results show that replacing the government’s debts with tax leads to the increase in private consumption and it is a sign of debt illusion in Iranian economy.