Unexpected Consequences of Ricardian Expectations

Economists are widely familiar with the Ricardian equivalence
thesis. It maintains that, given the time-path of government
spending, a change in taxation does not alter the set of feasible
life-time consumption plans of the households and affects neither
the demand for commodities and services nor the rate of interest,
provided the households act rationally. In this note a surprising
finding is established. Assuming that the agents in a standard
infinite horizon growth model hold the very expectations the thesis
proposes (“Ricardian expectations”), it is shown that these
expectations are disappointed. This divergence from the Ricardian
equivalence thesis is traced to the omission of interest payments
on public debt as part of the households' disposable income. The
non-equivalence is valid in a wide class of models. Further it is
shown that a permanent deficit policy does not imply a violation of
the government's budget constraint at any point of time in the
future.