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

30 Pages Posted: 15 Feb 2006

See all articles by Hamid Faruqee

Hamid Faruqee

International Monetary Fund (IMF) - Research Department

Douglas Laxton

International Monetary Fund (IMF) - Research Department

Steven Symansky

International Monetary Fund (IMF) - Fiscal Affairs Department

Date Written: December 1996

Abstract

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.

Keywords: Ricardian Equivalence, Crowding Out, Real Interest Rates, Government Debt

JEL Classification: E62, H31, E20, E21, E27

Suggested Citation

Faruqee, Hamid and Laxton, Douglas and Symansky, Steven, Government Debt, Life-Cycle Income and Liquidity Constraints: Beyond Approximate Ricardian Equivalence (December 1996). IMF Working Paper No. 96/140, Available at SSRN: https://ssrn.com/abstract=883037

Hamid Faruqee (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Douglas Laxton

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Steven Symansky

International Monetary Fund (IMF) - Fiscal Affairs Department ( email )

700 19th Street, NW
Washington, DC 20431
United States

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