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Government Debt, Life-Cycle Income, and Liquidity Constraints: Beyond Approximate Ricardian Equivalence

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Listed:
  • Hamid Faruqee

    (International Monetary Fund)

  • Douglas Laxton

    (International Monetary Fund)

  • Steven Symansky

    (International Monetary Fund)

Abstract

Evans (1991) has demonstrated that Blanchard's (1985) finite-horizon model obeys approximate Ricardian equivalence. This paper shows that this result is determined largely by an unrealistic assumption that labor income grows monotonically over the consumer's entire lifetime. With more realistic lifetime earnings profiles, the effects of government debt on the real interest rate and the capital stock are considerably larger. In particular, leaving aside the effects of distortionary capital taxation, the extended model with liquidity constraints predicts that real interest rates would decline by about 150-200 basis points if government debt were eliminated completely in all countries of the Organization for Economic Cooperation and Development (OECD).

Suggested Citation

  • Hamid Faruqee & Douglas Laxton & Steven Symansky, 1997. "Government Debt, Life-Cycle Income, and Liquidity Constraints: Beyond Approximate Ricardian Equivalence," IMF Staff Papers, Palgrave Macmillan, vol. 44(3), pages 374-382, September.
  • Handle: RePEc:pal:imfstp:v:44:y:1997:i:3:p:374-382
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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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