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

Hamid Faruqee, Douglas Laxton and Steven Symansky
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Steven Symansky: International Monetary Fund

IMF Staff Papers, 1997, vol. 44, issue 3, 374-382

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).

JEL-codes: E20 E21 E27 E62 H31 (search for similar items in EconPapers)
Date: 1997
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