Monday, September 19, 2005

Ricardian Equivalence as a Normative Proposal

Battlepanda brings up Ricardian equivalence as a normative proposal:
Jacob at Everybody's Illusion say that if you have a cow with the deficit and its impact on future generations, simply work out your share of the deficit and square that money away as treasury bonds. Gift the money to your kids with the understanding that it is for repaying the deficit when it finally gets called in. Since the money you put away will be the same money that you would pay if taxes were raised tomorrow to pay for the deficit, surely it's six-of-one/half dozen of the other. Sounds good, right?
Well, as someone wise once said (though I can't remember whom), economic models have two lives: once as positive models, and if that doesn't work, as normative models. That is, economic models deal with rational agents who do what is best for themselves. If people turn out not to act like that, then maybe they *should* be acting like that. Ricardian equivalence is once example. It's totally useless at describing actual consumption behavior, but perhaps people should act in a way consistent with it. After all if taxes *must* be raised to pay off the debt, then you'd want to smooth your consumption, presumably.


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