1. Macroeconomic Analysis 2003
Fiscal Policy 2: Ricardian Equivalence Theorem
And Inflation Tax
Lecture 15

2. Contents Main point of the Ricardian Equivalence Theorem (RET)
Graphical and Algebraic Illustration of RET
Numerical Example of RET
Limitations of RET
Deficit financing by printing money:Seigniorage
Optimal Inflation tax rate
Why governments like inflation tax?
Dangers of excessive inflation
Lecture 15

3. Ricardian Equivalence: Main Proposition
How important is a tax cut?
Should government finance deficit by borrowing or by raising taxes?
Ricardian Equivalence Theorem is after David Ricardo.
British economist, who wrote about 180 years ago that it does not matter whether government finances its deficit by
borrowing or
taxes.
Lecture 15

4. Ricardian Equivalence: Main Proposition
If it borrows now it raises tax in future for repayment of its debt.
With more current debt private households save more in anticipation of higher taxes in the future that government will impose on them to repay the debt.
Private households optimise intertemporally and completely internalise public policy.
Borrowing only or tax only strategy does not matter if both the government and household honour their own inter temporal budget constraints.
Lecture 15

5. Basic Proposition of the Ricardian Equivalence Tax or Borrowing Does not Make Any Difference
Tomorrow C2
Before Borrowing
Budget Constraint
After borrowing
budget constraint C1
Today
Lecture 15

6. Model Economy for Ricardian Equivalence Theorem
Lecture 15

7. Tax Spending and Borrowing Strategies
Lecture 15

8. Optimisation for Ricardian Equivalence Theorem
Lecture 15

9. Conclusion of the Ricardian Equivalence Theorem
Lecture 15

10. Numerical Proof of Ricardian Equivalence Theorem -1
Lecture 15

11. Borrowing strategy: period 1 borrowing of 30
Lecture 15

12. Limitations of Ricardian Equivalence Theorem
Lecture 15

13. Deficit Financing by Printing Money
Lecture 15

14. Inflation Tax: A Numerical Example
Lecture 15

15. Lecture 15

16. Lecture 15

17. Exercises
Does it make difference if the deficit if financed by more taxes or by more borrowing?
Proof of Ricardian Equivalence
Household utility with and without public goods
Implications of borrowing from the private sector or the central bank
How does inflation tax reduce the debt burden for governments?
Lecture 15