Ricardian Equivalence: An Argument for Countercyclical Fiscal Policies

Ricardian equivalence has crucial importance in the fiscal policy considerations of new classical macroeconomics. When assessing Ricardian equivalence or any of the new classical doctrines, one should bear in mind the conditional character of of these theses. The equivalence theorem should not be separated from the assumptions on which it is based. In other words, Ricardian equivalence does not mean the failure of any countercyclical efforts, but underlines the necessary conditions for this failure and, naturally, for the success at the same time. Governments do not have any potential to exert countercyclical efforts if the path of government expenditures is fixed and if agents form rational expectations. If these conditions hold, cuts in taxes imply a later pressure to rise taxes, since government has to fill the resource gap in the budget which is the result of the initial tax cut. So, rational agents treasure up the additional income from the tax cut and consumption does not rise. In this story, public operations should stand in the focus of reasoning: if these processes can be changed by the government, or, in any way, the additional income can be believed not to be withdrawn later, the initial tax cut will induce a rise in consumption expenditures. So, any of the conditions necessary for the equivalence does not hold, countercyclical fiscal policy can be effective. Controlling the real economy is possible perhaps even in a Keynesian style if government regains its potential to exert this control. Therefore, actually, new classical macroeconomics highlights the conditions under which fiscal policy can be effective and not the inefficiency of fiscal policy. Countercyclical aspirations need not to be abandoned, only the playing-field of economic policy got narrowed by new classicals. Although Keynes urged active countercyclical efforts of fiscal policy, these efforts are not predestined to fail not even in the new classical theory, only the conditions necessary for the efficiency of countercyclical efforts were specified by new classicals. Ricardian equivalence underlines the importance of fiscal reforms, since such reforms are needed in order to change the path of government expenditures. When implementing comprehensive fiscal reforms which make public sector more efficient governments do not exert countercyclical efforts of course, but form the necessary conditions for regaining countercyclical potential. In this respect, Ricardian equivalence clarifies the exact conditions necessary for countercyclical fiscal policies.

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