Ricardian Equivalence

Explain Ricardian equivalence, and discuss what implication it might have on the efficacy of expansionary fiscal policy.

Ricardian equivalence states that for a given level of government spending a change in taxes – financed by a deficit – will have no effect on the real economy. It is posited that individuals are forward thinking and rational and realise that a tax break today will have to be paid in the future. Therefore individuals won’t go out and spend this tax cut but will instead save it so that they can smooth consumption.

They will save ΔT.r (tax cut multiplied by real interest rate), acknowledging that the government will have to pay interest on its debt so future taxation will need to incorporate this. [...]

US Default

There has been a lot in the news recently about the possibility of a US default – what does this mean? A default is a term used for when a country refuses to pay its debt. Generally this is because they can no longer afford to, however there could be other reasons, e.g. a change of government brings in a socialist regime whose policy was to default. A default may not be of the entire debt, debtors may be required to take a ‘haircut’ – which is considered a default – meaning they wont be paid back the entire amount they are owed. [...]