Mankiw 6e PowerPoints
Download
Report
Transcript Mankiw 6e PowerPoints
Ricardian equivalence
due to David Ricardo (1820),
more recently advanced by Robert Barro
According to Ricardian equivalence,
a debt-financed tax cut, holding G constant, has
no effect on consumption, national saving, the
real interest rate, investment, net exports, or real
GDP, even in the short run.
The logic of Ricardian Equivalence
Consumers are forward-looking and base
spending on current and expected future income permanent Income/ Life Cycle Hypothesis
Consumers are forward-looking and know that a
debt-financed tax cut today implies an increase in
future taxes that is equal – in present value – to
the tax cut.
The tax cut is transitory income.
The logic of Ricardian Equivalence
The tax cut does not make consumers better off,
so they do not increase consumption spending.
Consumers save the full tax cut in order to repay
the future tax liability.
Result: Private saving rises by the amount
public saving falls, leaving national saving
unchanged, r unchanged, I unchanged, Y
unchanged.
The logic of Ricardian Equivalence
A tax cut financed by government debt does not
reduce the tax burden, it just reschedules the
tax.
Arguments against Ricardian Equivalence
Myopia: Not all consumers think so far ahead,
some see the tax cut as a windfall or an increase
in life time income.
Borrowing constraints: Some consumers
cannot borrow enough to achieve their optimal
consumption, so they spend a tax cut.
Future generations: If consumers expect that
the burden of repaying a tax cut will fall on future
generations, then a tax cut now makes them feel
better off, so they increase spending.
Questions:
Suppose consumers understand that the tax cut
today is to be followed by a decrease in
government spending in the future. Would
consumption increase?
How about an announcement about a reduction
in government spending in the future. Could this
affect consumption today?
Bush 1992 withholding
Lower withholding, but pay up in the following
April.
RE predicts no change in consumption because
life time resource(income) was not changed transitory
Survey – 57% said would save and 43% spend.
Most studies show MPC out of temporary tax
change < MPC out of permanent tax change.