A Primer on Ricardian Equivalence

A primer on Ricardian equivalence, government debt, and deficits from John Seater in the Concise Encyclopedia of Economics:

A related issue is the desirability of deliberately using deficits to influence the path of the economy. Under full equivalence of deficit and tax finance, no such thing can be done, of course, because deficits do not affect anything important. Under incomplete equivalence, though, deficits do have effects, as we have just seen. Therefore, it might seem desirable to run up deficits in recessions to encourage people to spend more and to run up surpluses in booms to restrain spending. One problem is that these seemingly desirable effects arise only because people fail to perceive the future taxes implied by deficits; that is, deficits have effects only when they fool people into thinking they suddenly have become wealthier (and conversely for surpluses). Is it desirable to influence the path of the economy by using a policy that is effective only because it deliberately misleads the public? Such a proposition seems difficult to justify. Another problem is that any desirable effects are accompanied by other effects that might not be deemed desirable. When equivalence is incomplete, changing the stock of debt outstanding also changes the interest rate in the same direction. In particular, running a deficit in a recession would raise interest rates, which would reduce investment and economic growth, which in turn would reduce output in the future. Thus, using deficits to stimulate the economy now to ameliorate a recession comes at the cost of reducing output later. Whether that is a good exchange is not obvious and requires justification.

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