A current-period tax reduction financed by issuing government shifts the timing of tax collection from the current period to the future. If the future taxes implied by government are not fully perceived and discounted by the private sector, there will be a net effect that increases private sector consumption, thus reducing capital accumulation and growth. If, on the other hand, the implied future taxes are perceived and discounted by the private sector, the current-period tax reduction will be used to increase private saving to pay for the future taxes, and government will be absorbed without any real effects on the economy.' The effects of government spending financed by current-period taxation also depend upon private sector perceptions.2 If the benefits of government spending are ignored, private sector consumption will decrease in accordance with the reduction in permanent disposable income. To the extent that government spending is on consumption-type goods that are perceived as substitutes for privately provided consumption goods, there will be a relatively greater reduction in private sector consumption. To the extent that government spending is on investment-type goods yielding future goods and services that are perceived as substitutes for future privately provided consumption goods, there will be a relatively smaller reduction in private sector consumption. The to modeling private sector consumption-saving behavior involves a rather asymmetric set of assumptions as to how the private sector perceives the various elements of government fiscal policy.3 Current-period taxes are assumed to be fully perceived, but current-period government spending is implicitly assumed to be completely ignored by the private sector. In considering permanent personal disposable income, the private sector is assumed to be forward-looking in its assessment of income and taxation. The stock of government is nevertheless included as part of the stock of private wealth, the implicit assumption *Associate Professor of Economics, Graduate School of Business, University of Chicago, 1101 East 58th Street, Chicago, IL 60637. I thank Eugene Fama, Levis Kochin, Michael Mussa, Paul Evans, and an anonymous referee for helpful comments. I am particularly grateful to Daniel Benjamin for contributing many hours of discussion, and Laura Lahaye, who was a research assistant and valuable adviser on earlier drafts. 'The theoretical debate on the burden of the debt has been long standing. Gerald O'Driscoll (1977) documents Ricardo's nineteenth-century position. Robert Barro (1974) reopened the debate by introducing the fundamental issue of intergenerational transfers (also discussed in Merton Miller and Charles Upton, 1974). The empirical side of the debate was initiated by Levis Kochin's (1974) attempt to test for the effects of deficits on consumption and by Martin Feldstein's (1974) attempt to test for the effects of Social Security wealth on consumption. Other empirical contributions include Jess Yawitz and Laurence Meyer (1976), myself (1978) and J. Earnest Tanner (1978, 1979) with respect to the effects of government deficits and debt, and Barro (1978), Michael Darby (1979), and Dean Leimer and Selig Lesnoy (1982) with respect to Social Security wealth. See also interesting recent papers by John Seater (1982), who generates detailed tests of the effects of deficits and on consumption, Charles Plosser (1982), who explores the effects of government spending and shocks on interest rates, and Feldstein (1982), who attempts tests similar to some in this paper (see fn. 29). 2Martin Bailey's (1962, 1971) development of the effects of government spending on private consumption and aggregate economic activity is the seminal contribution. Paul David and John Scadding (1974) extend Bailey's ideas and provide some supporting empirical evidence. More recently, Willem Buiter (1977) and myself (1978) developed models based on Bailey's earlier work. Barro (1981) has an interesting paper on related issues. See also David Aschauer (1982). 3The standard approach incorporates fiscal policy through the concept of personal disposable income and by including the stock of government as part of personal wealth. See, for example, the empirical specification of Albert Ando and Franco Modigliani (1963), which has been the basis of most empirical consumption studies since, and Feldstein (1974) for one of the more influential papers based on the Ando-Modigliani specification.

Roger Kormendi (1983) presents apparently strong evidence that, in contrast to the standard view, consumption is not reduced by taxes but is reduced by government expenditure. He interprets his results as supporting a consolidated approach to private sector behavior in which consumers effectively internalize the government budget constraint. Specifically, he claims that consumers regard government spending as the true measure of the government's claim on private resources, and so do not respond to changes in taxes, given spending. This is basically the approach advocated by Robert Barro (1974) and known also as the Ricardian Equivalence Proposition (hereafter REP). Kormendi's results appears to contradict other empirical work based on the Life Cycle Hypothesis (for example, Martin Feldstein, 1982; Modigliani 1984a; Sterling, 1985) although results similar to his have been reported (see David Aschauer, 1985; John Seater and Roberto Mariano, 1985 and the references in Kormendi). In our view, Kormendi's analysis is seriously flawed. His heuristic derivation of the consumption function leads him to a specification of the aggregate consumption function, which is not consistent with the Life Cycle Hypothesis (LCH) or with REP, and to questionable methods of estimation. Once his conceptual and methodological errors are corrected, his formulation and, more generally, the REP hypothesis are found to receive little empirical support. In the next section we rely on the LCH to derive an aggregate consumption function which shows explicitly how government expenditure and taxes should effect private consumption. This derivation helps to bring out the observable implications of REP, which are shown to be equivalent to a limiting form of the LCH in which the planning horizon is infinite. It also serves to clarify the appropriate specification of the variables appearing in the consumption function. Next, Section II reports our empirical estimates and tests. Section III compares our results with Kormendi's. Finally, Section IV reports the results of endeavors to improve the specification of fiscal variables, notably by distinguishing between permanent and transitory tax changes.

The preceding articles by Martin Feldstein and Douglas Elmendorf and by Franco Modigliani and Arlhe Sterling give us a welcome opportunity to return to the effects of fiscal policy on private consumption. At stake in this debate, we believe, is a potential paradigm change-from what Kormendi (1983) termed the Standard Approach, which bases private consumption on disposable personal income, to what he termed the Consolidated Approach, which bases consumption on aggregate income, government spending, and transfer payments, each with separate effects. The Standard Approach excludes Ricardian equivalence a priori. The Consolidated Approach not only incorporates Ricardian equivalence but, in its augmented form, allows one to nest the various hypotheses associated with the two approaches. Feldstein and Elmendorf argue that Kormendi's (1983) results (and implicitly those of Kormendi and Meguire, 1986), which reject the Standard Approach in favor of the Consolidated/Ricardian alternative, are not robust to the exclusion of data from World War II and other specification changes. Modigliani and Sterling argue that accounting for temporary taxes reverses our rebuttal of their 1986 comment. We first take up the challenge of Feldstein and Elmendorf before turning to Modigliani and Sterling. We then assess the validity of our preference for estimating in differences, by testing whether consumption, income, and the fiscal variables are cointegrated. Finally, we summarize what can be learned from the debate. I. Feldstein and Elmendorf

Rational expectations macromodels predict that the short-run effects of monetary shocks on real output (X) should be negatively related across policy regimes to the variability of such shocks. This paper presents cross-regime tests of this and related propositions based on a sample of 47 countries. The within-regime estimates reveal a consistent pattern of positive short-run real output effects, with neutrality of money holding in the long run. The cross-regime tests show that X is negatively related to the variance of monetary shocks, positively related to the variance of real output shocks, negatively related to the variance of velocity shocks, and unrelated to either the mean or variance of anticipated money growth.

Rational expectations macromodels predict that the short-run effects of monetary shocks on real output (X) should be negatively related across policy regimes to the variability of such shocks. This paper presents cross-regime tests of this and related propositions based on a sample of 47 countries. The within-regime estimates reveal a consistent pattern of positive short-run real output effects, with neutrality of money holding in the long run. The cross-regime tests show that X is negatively related to the variance of monetary shocks, positively related to the variance of real output shocks, negatively related to the variance of velocity shocks, and unrelated to either the mean or variance of anticipated money growth.