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Sunday, January 01, 2012

More "Ricardianoid" Equivalence

Robert Barro:

It's never part of Ricardian equivalence that the level of government expenditure doesn't matter.

John Cochrane:

Ricardian Equivalence ... is the theorem that stimulus does not work in a well-functioning economy...

Paul Krugman:

...John Cochrane weighs in on the Ricardian equivalence debate, sort of. I say “sort of” because he defines Ricardian equivalence as

the theorem that stimulus does not work in a well-functioning economy

which isn’t at all what it means to the rest of us, and certainly not what Ricardo meant (for the record, it’s the proposition that the timing of taxes doesn’t matter for consumer spending, so that temporary tax cuts don’t change spending).

And then he “explains” that government spending can’t increase demand because of … Say’s Law! Which, of course, Keynesian economists have never thought of.

It’s quite remarkable. And I mean that in the worst way: 80 years of hard thinking about economics, completely forgotten.

Update: Brad DeLong:

Department of "Huh?!": John Cochrane and Ricardian Equivalence Edition I: "Ricardian Equivalence"--a theory not believed in by David Ricardo--is the claim that when the government cuts lump-sum taxes or increases lump-sum transfers in the present and balances this by a credible announcement that it will increase lump-sum taxes in the future such a shift in the economy has no effect on spending, prices, production, or interest rates. For Ricardian equivalence to hold, we need for:

  • people to be able to borrow and lend as much as they want at the market interest rate.
  • people to be your standard non-myopic economic agents.
  • people to care only about the subjective utility of their descendants.
  • everybody to leave a positive bequest to each of their descendants.
  • everybody to have some descendants.
  • nobody immigrates or emigrates.

To the extent that people cannot borrow and lend at the market interest rate, that people are myopic, that people care about descendants in other ways than seeking to maximize their subjective utility, that people don't leave bequests to all their descendants, that people don't have descendants, and that people immigrate or emigrate, Ricardian Equivalence will fail. How much it will fail depends on the magnitudes, etc., but fail it does.

This definition of a "well-functioning economy" is not something I understand...

A quick summary is to say that financial markets must be efficient, agents must be rational maximizers, and there has to be a sufficient degree of "connectedness" between generations (within a given country -- immigration or emigration breaks this).

Update: See also Brad DeLong's Department of "Huh?!": John Cochrane and Ricardian Equivalence II, and, for emphasis, Department of "Huh?!": John Cochrane III.

    Posted by on Sunday, January 1, 2012 at 12:12 PM in Economics | Permalink  Comments (35)


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