Does Ricardian Equivalence hold with when borrowing constraints are binding?
Ricardian Equivalence, also known as Ricardo-De Viti-Barro Equivalence theorem, is an economics hypothesis stating that an increase in government borrowing to finance their spending may have no impact on consumer spending and aggregate demand. This is because consumers predict tax cuts or higher government spending to stimulate the economy will result in future taxes increase to pay back the debt. Therefore whatever they gain now will be offset by future taxes raise. Assumptions under Ricardian Equivalence are:
Consumers are rational and farsighted
They live forever and (or) care about their ancestors as much as they care about themselves
They believe that current …show more content…
Even if consumers care about the tax burden for next generation occurred from the current budget deficit, they can argue that the increase in population will redistribute taxes and their children will not be in difficulties with paying back.
Liquidity constraints are needed to be eliminated in order for Ricardian Equivalence to hold. To explain this, consider this example. If consumer A wishes to spend more today knowing that his future income can pay for his current transactions, then consumer A only need to borrow money from the a bank or funds. As such, a tax cut would not change his spending decisions because he can borrow to enjoy his purchase as a result he would save the tax rebate and Ricardian Equivalence will …show more content…
The increase in housing prices together with government deregulation and the lowering standards to market mortgages led to the substantial amount of real estate loans spreading throughout the financial system. When house values failed to increase and the homeowner cannot keep up with their payments, banks were forced to admit write-downs and writes offs on these toxic products. This consequently led to the bankruptcy of some banking institutions. The impacts of this bankruptcy resulted in the fails in firms as they cannot access to loans and consequently increased unemployment. It also further damaged production and output
Ricardian Equivalence, also known as Ricardo-De Viti-Barro Equivalence theorem, is an economics hypothesis stating that an increase in government borrowing to finance their spending may have no impact on consumer spending and aggregate demand. This is because consumers predict tax cuts or higher government spending to stimulate the economy will result in future taxes increase to pay back the debt. Therefore whatever they gain now will be offset by future taxes raise. Assumptions under Ricardian Equivalence are:
Consumers are rational and farsighted
They live forever and (or) care about their ancestors as much as they care about themselves
They believe that current …show more content…
Even if consumers care about the tax burden for next generation occurred from the current budget deficit, they can argue that the increase in population will redistribute taxes and their children will not be in difficulties with paying back.
Liquidity constraints are needed to be eliminated in order for Ricardian Equivalence to hold. To explain this, consider this example. If consumer A wishes to spend more today knowing that his future income can pay for his current transactions, then consumer A only need to borrow money from the a bank or funds. As such, a tax cut would not change his spending decisions because he can borrow to enjoy his purchase as a result he would save the tax rebate and Ricardian Equivalence will …show more content…
The increase in housing prices together with government deregulation and the lowering standards to market mortgages led to the substantial amount of real estate loans spreading throughout the financial system. When house values failed to increase and the homeowner cannot keep up with their payments, banks were forced to admit write-downs and writes offs on these toxic products. This consequently led to the bankruptcy of some banking institutions. The impacts of this bankruptcy resulted in the fails in firms as they cannot access to loans and consequently increased unemployment. It also further damaged production and output