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Government Debt, Life-Cycle Income and Liquidity Constrains; Beyond Approximate Ricardian Equivalence

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  • Steven A. Symansky
  • Douglas Laxton
  • Hamid Faruqee

Abstract

Evans (1991) has demonstrated that Blanchard’s (1985) finite-horizon model obeys approximate Ricardian equivalence. We show that this result is determined largely by an unrealistic assumption that labor income grows monotonically over a consumer’s entire lifetime. Introducing more realistic lifetime earnings profiles, we find that the effects of government debt on the real interest rate and the capital stock become 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 OECD countries.

Suggested Citation

  • Steven A. Symansky & Douglas Laxton & Hamid Faruqee, 1996. "Government Debt, Life-Cycle Income and Liquidity Constrains; Beyond Approximate Ricardian Equivalence," IMF Working Papers 96/140, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:96/140
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    Keywords

    Debt; Ricardian Equivalence; Crowding Out; Real Interest Rates; Government Debt; real interest rate; lifetime income; disposable income; public debt;

    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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