Page 15 - FINAL CFA I SLIDES JUNE 2019 DAY 6
P. 15
Session Unit 5:
18. Monetary and Fiscal Policy
Ricardian Equivalence, p. 122
A government runs a deficit today, means higher taxes in future!
Ricardian Equivalence –tax payers can anticipate this future higher taxes and protect
themselves by taking advantage of the extra income from the deficit spending (not consume it,
but save it), and then use that to offset the expected cost of higher future taxes.
If the total reduction in C (and increase in S) is by just enough to repay the principal and
interest on the debt the government, there is no effect on AD.
If taxpayers underestimate their future liability for servicing and repaying the debt, so that AD is
increased by equal spending and tax increases, Ricardian equivalence does not hold.
Jury is still out!
