by Robert Waldmann
“Ricardo offers us the supreme intellectual achievement, unattainable by weaker spirits, of adopting a hypothetical world remote from experience as though it were the world of experience and then living in it consistently. With most of his successors common sense cannot help breaking in — with injury to their logical consistency.” J M Keynes (1936) “The General Theory of Employment Interest and Money appendix to chapter 14).
With decades of effort, economists have managed to keep common sense from breaking in even when Ricardo himself couldn’t. Ricardian equivalence is a totally silly idea. Even Ricardo had enough sense to see that. In this case he understood that actual real world economic agents weren’t rational in the sense of having beliefs consistent with his model.
Numerous commentators over at Krugman’s blog (link for a link and thanks) challenge Krugman’s claim about the extreme implications of Ricardian equivalence.
Even leaving aside the implausible assumptions, what rational householder would plan present and future spending on the proposition that government debt must be repaid with future taxes? The United States has never paid its national debt and never will. It simply accumulates. Moreover, there is no discernible relationship between the level of taxes and debt. How is it rational to assume something will happen in the future that has never happened before?
However, the fact that the national debt never reaches zero and even the fact that budget surpluses are small and rare does not mean that there is no Ricardian equivalence What would be needed is for the present value of debt at time t discounted to time now to not fall to zero as t goes to infinity. So not the debt but the debt discounted to now. That condition about the discounted value has to hold in models with a rational representative agent. So it is a requirement of (foolish) consistency to assume it.
“is that even a helicopter drop of money has no effect in a world of Ricardian equivalence, since you know that the government will eventually have to tax the windfall away.”
No. True helicopter money doesn’t have to be taxed away. But even if it did, Ricardian equivalence has nothing to do with the hesitation of consumers to spend when given some extra cash.
This state is doubly wrong.
1) damn autocorrect and
2) We are commentino on Friedman Who (reasonably) calla the reduction in valute of money holdings due to inflation “inflation tax”. With a helicopter drop either the economay stays in the liquidity trap forever or eventually the real balances reach the same equilibrium value so the added money exactly equals the present value of added losses due to inflation. Krugman did the math right (he tenda to).
my wife’s iPad corrects my English to Italian. To tradurre
We are commenting on Friedman Who (reasonably) called the reduction in valute of money holdings due to inflation “inflation tax”. With a helicopter drop either the economy stays in the liquidity trap forever or eventually real balances reach the same equilibrium value, so the added money exactly equals the present value of added losses due to inflation. Krugman did the math right (he tends to).
In reply to another comment about how money is not like bonds because it doesn’t mature, I note that commenters think that Krugman solved a simple model with a representative consumer wrong over a decade ago and hasn’t noticed the error nor has anyone pointed it out. This is not likely. Contemporary macroeconomists may have no common sense at all, but we can handle a bit of math.
Also Krugman has some common sense, but the point here is that he can do standard macro math.