Government Debt, Life-Cycle Income and Liquidity Constrains: Beyond Approximate Ricardian Equivalence
December 1, 1996
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Summary
Evans (1991) has demonstrated that Blanchard’s (1985) finite-horizon model obeys approximate Ricardian equivalence. We show that this result is determined largely by an unrealistic assumption that labor income grows monotonically over a consumer’s entire lifetime. Introducing more realistic lifetime earnings profiles, we find that the effects of government debt on the real interest rate and the capital stock become 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 OECD countries.
Subject: Consumption, Disposable income, Financial services, Income, National accounts, Public debt, Real interest rates
Keywords: Blanchard model, capital stock, Consumption, consumption function, Crowding Out, debt accumulation, debt buildup, debt issue, debt ratio, Disposable income, Government Debt, Income, income consumer, income hypothesis, income profile, life-cycle income, real interest rate, Real Interest Rates, real rate of interest, Ricardian Equivalence, WP
Pages:
30
Volume:
1996
DOI:
Issue:
140
Series:
Working Paper No. 1996/140
Stock No:
WPIEA1401996
ISBN:
9781451928778
ISSN:
1018-5941
Notes
Also published in Staff Papers, Vol. 44, No. 3, September 1997.
