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Chapter 10 Ricardian Equivalence 10.1. Borrowing limits and Ricardian equivalence This chapter studies whether the timing of taxes matters. Under some assumptions it does, and under others it does not. The Ricardian doctrine describes assumptions under which the timing of lump taxes does not matter. | Chapter 10 Ricardian Equivalence 10.1. Borrowing limits and Ricardian equivalence This chapter studies whether the timing of taxes matters. Under some assumptions it does and under others it does not. The Ricardian doctrine describes assumptions under which the timing of lump taxes does not matter. In this chapter we will study how the timing of taxes interacts with restrictions on the ability of households to borrow. We study the issue in two equivalent settings 1 an infinite horizon economy with an infinitely lived representative agent and 2 an infinite horizon economy with a sequence of one-period-lived agents each of whom cares about its immediate descendant. We assume that the interest rate is exogenously given. For example the economy might be a small open economy that faces a given interest rate determined in the international capital market. Chapter 13 will describe a general equilibrium analysis of the Ricardian doctrine where the interest rate is determined within the model. The key findings of the chapter are that in the infinite horizon model Ricardian equivalence holds under what we earlier called the natural borrowing limit but not under more stringent ones. The natural borrowing limit is the one that lets households borrow up to the capitalized value of their endowment sequences. These results have counterparts in the overlapping generations model since that model is equivalent to an infinite horizon model with a noborrowing constraint. In the overlapping generations model the no-borrowing constraint translates into a requirement that bequests be nonnegative. Thus in the overlapping generations model the domain of the Ricardian proposition is restricted at least relative to the infinite horizon model under the natural borrowing limit. - 306 - Infinitely lived-agent economy 307 10.2. Infinitely lived-agent economy An economy consists of N identical households each of whom orders a stream of consumption of a single good with preferences 00 Y Uct 10.2.1
