Modeling and Testing Ricardian Equivalence: A Survey

Abstract

A central proposition regarding effects of different mechanisms of financing public expenditures is that, under specific circumstances, it makes no difference to the level of aggregate demand if the government finances its outlays by debt or taxation. This so-called Ricardian equivalence states that, for a given expenditure path, substitution of debt for taxes does not affect private sector wealth and consumption. This paper provides a model illustrating the implications of Ricardian equivalence, surveys the literature, considers effects of relaxing the basic assumptions, provides a framework to study implications of various extensions, and critically reviews recent empirical work on Ricardian equivalence.