Ricardian Equivalence
Candlefocus EditorThe concept was first proposed in 1817 by 19th-century British economist David Ricardo as a result of his analysis of the costs and benefits of borrowing for public projects. He argued that, although public borrowing can provide an immediate economic stimulus, it results in a long-term net transfer of resources from taxpayers to creditors. If taxpayers understand this, they will save for future taxation to pay off the government debt, effectively offsetting the stimulative effects of deficit spending.
In other words, Ricardian Equivalence says that taxpayers, if they are informed and rational, will save enough money to pay the future tax bills when deficits are incurred, and thus will not increase their spending. This could lead to a neutral effect with regards to the stimulative power of deficit spending.
The concept of Ricardian Equivalence gained more attention and influence in the late twentieth century, when it was studied in the context of how the public responds to changes in government debt. Many economists felt that this theory contradicted the Keynesian view that increased spending could boost short-term economic output.
Ricardian Equivalence has been the subject of considerable debate among economists for many years. Some argue that it overlooks the fact people may not have the resources availble to save immediately and long-term implications could differ significantly from the original expectation. Other economists view the theory as being a factual description of economic behaviour, and suggest that its implications should at least be taken seriously.
In conclusion, Ricardian Equivalence is an interesting economic concept which challenges many of the traditional economic assumptions about government-funded deficit spending and its ability to stimulate the economy. Whilst it has been debated vehemently over the years, it continues to cast doubt on traditional macroeconomic views and has undoubtedly been a major contributor to the evolution of economics.