閤 The ricardian Approach to Budget Deficits OR。 Robert J. barro The Journal of Economic Perspectives, Vol 3, No. 2. (Spring, 1989), pp. 37-54 Stable url: http://inks.jstororg/sici?sici=0895-3309%28198921%0293%3a2%03c37%03atratbd%3e2.0.co%3b2-7 The Journal of Economic Perspectives is currently published by American Economic Association Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyouhaveobtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the jsTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at Each copy of any part of a JSTOR transmission must contain the same copyright notice that ap on the screen or printed page of such transmission STOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support @jstor. org Thu mar1505:32:052007
The Ricardian Approach to Budget Deficits Robert J. Barro The Journal of Economic Perspectives, Vol. 3, No. 2. (Spring, 1989), pp. 37-54. Stable URL: http://links.jstor.org/sici?sici=0895-3309%28198921%293%3A2%3C37%3ATRATBD%3E2.0.CO%3B2-7 The Journal of Economic Perspectives is currently published by American Economic Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/aea.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor.org. http://www.jstor.org Thu Mar 15 05:32:05 2007
Journal of Economic Perspectiues-Volume 3, Number 2-Spring 1989-Pages 37-54 The Ricardian Approach to Budget Deficits Robert j. Barro n recent years there has been a lot of discussion about U. S. budget deficits. Many economists and other observers have viewed these deficits as harmful to the U. S and world economies. The supposed harmful effects include high real int rates, low saving, low rates of economic growth, large current-account deficits in the United States and other countries with large budget deficits, and either a high or low dollar(depending apparently on the time period). This crisis scenario has been hard to maintain along with the robust performance of the U.S. economy since late 1982. This performance features high average growth rates of real GNP, declining unemploy ment, much lower inflation, a sharp decrease in nominal interest rates and some decline in expected real interest rates, high values of real investment expenditures, and (until October 1987)a dramatic boom in the stock market. Persistent budget deficits have increased economists' interest in theories and evidence about fiscal policy. At the same time, the conflict between standard predi tions and actual outcomes in the U.S. economy has, I think, increased economist to consider approaches that depart from the standard paper I will focus on the alternative theory that is associated with the name of David Ricardo The Standard Model of Budget Deficits Before developing the Ricardian approach, I will sketch the standard model. The starting point is the assumption that the substitution of a budget deficit for current a Robert Barro is Professor of Economics, Harvard Uniuersity, Cambridge, Massachusetts, search Associate, National Bureau of Economic Research, Cambridge, Massachusetts; Research Associate, Rochester Center for Economic Research, University of Rochester, Rochester, New york
38 Journal of Economic Perspectives taxation leads to an expansion of aggregate consumer demand. In other words, desired private saving rises by less than the tax cut, so that desired national saving declines. It follows for a closed economy that the expected real interest rate would have to rise to restore equality between desired national saving and investment demand The higher eal interest rate crowds out investment, which shows up in the long run as a sm stock of productive capital. Therefore, in the language of Franco Modigliani (1961), the public debt is an intergenerational burden in that it leads to a smaller stock of capital for future generations. Similar reasoning applies to pay-as-you-go social security programs, as has been stressed by Martin Feldstein(1974). An increase in the scope of these programs raises the aggregate demand for goods, and thereby leads to a higher real interest rate and a smaller stock of productive capital In an open economy, a small country' s budget deficits or social security programs would have negligible effects on the real interest rate in international capital markets Therefore, in the standard analysis, the home countrys decision to substitute a budget deficit for current taxes leads mainly to increased borrowing from abroad, rather than to a higher real interest rate. That is, budget deficits lead to current-account deficits Expected real interest rates rise for the home country only if it influence world markets, or if the increased national debt induces foreign lenders to demand higher expected returns on this countrys obligations. In any event weaker tendency for a country's budget deficits to crowd out its domestic investment in the short run and its stock of capital in the long run. However, the current-account deficits show up in the long run as a lower stock of national wealth -and correspond ingly higher claims by foreigner If the whole world runs budget deficits or expands the scale of its social insurance rograms, real interest rates rise on international capital markets, and crowding-out of investment occurs in each country. Correspondingly, the world's stock of capital is lower in the long run. These effects for the world parallel those for a single closed before The Ricardian Alternative The Ricardian modification to the standard analysis begins with the observation that, for a given path of government spending, a deficit-financed cut in current taxes leads to higher future taxes that have the same present value as the initial cut. This result follows from the government,'s budget constraint, which equates total expendi- tures for each period (including interest payments)to revenues from taxation or other sources and the net issue of interest -bearing public debt. Abstracting from chain-letter cases where the public debt can grow forever at the rate of interest or higher, the present value of taxes(and other revenues)cannot change unless the government changes the present value of its expenditures. This point amounts to economists standard notion of the absence of a free lunch-government spending must be paid for now or later, with the total present value of receipts fixed by the total present value of spending. Hence, holding fixed the path of government expenditures and
Robert / Barro 39 non-tax revenues, a cut in today's taxes must be matched by a corresponding increase in the present value of future taxes. Suppose now that households'demands for goods depend on the expected present value of taxes-that is, each household subtracts its share of this present value from the expected present value of income to determine a net wealth position. Then fiscal policy would affect aggregate consumer demand only if it altered the expected present value of taxes. But the preceding argument was that the present value of taxes would not change as long as the present value of spending did not change. Therefore, the substitution of a budget deficit for current taxes(or any other rearrangement of the timing of taxes)has no impact on the aggregate demand for goods. In this sense, budget deficits and taxation have equivalent effects on the economy -hence the term Ricardian equivalence theorem. To put the equivalence result another way, a decrease in the government's saving (that is, a current budget deficit)leads to an offsetting increase in desired private saving, and hence to no change in desired Since desired national saving does not change, the real interest rate does not have to rise in a closed economy to maintain balance between desired national saving and investment demand. Hence, there is no effect on investment, and no burden of the public debt or social security in the sense of Modigliani(1961)and Feldstein(1974) n a setting of an open economy there would also be no effect on the current-account balance because desired private saving rises by enough to avoid having to borrow from abroad. Therefore budget deficits would not cause current-account deficits Theoretical Objections to Ricardian Equivalence I shall discuss five major theoretical objections that have been raised against the Ricardian conclusions. The first is that people do not live forever, and hence do not care about taxes that are levied after their death. The second is that private capital The calculations use the government's interest rate in each period to calculate present values, and assume perfect foresight with respect to future government expenditures and taxes. For further discussion see Ben McCallum(1984)and Robert Barro(1989) The term, Ricardian equivalence theorem, was introduced to macroeconomists by James Buchanan(1976) After Gerald O Driscoll(1977)documented Ricardo s reservations about this result some economists have referred to the equivalence finding as being non-Ricardian. But, as far as I have been able to discover, David Ricardo(1951)was the first to articulate this theory. Therefore, the attribution of the equivalence theorem to Ricardo is te even if he had doubts about some of the theorem's assumptions. As to whether the presence of this idea in Ricardos writings is important for scientific progress, I would refer to Nathan Rosenberg's(1976, p. 79)general views on innovations in the social sciences happens in economics is that, as concern mounts over a particular problem.. an increasing number of professionals commit their time and energies to it. We then eventually realize that there were all sorts of sophisticated present-day understanding back into the work of earlier writers whose analysis of our more treatments of the subject in the earlier literature.. We then proceed to read much inevitably nore fragmentary and incomplete than the later achievement. It was this retrospective view which doubtless inspired whitehead to say somewhere that everything of importance has been said before-but by someone who did not discover it. "(This last point relates to"Stigler's Law, which states that nothing named after the person who discovered it
40 Journal of Economic Pers markets are"imperfect, " "with the typical person s real discount rate exceeding that of the government. The third is that future taxes and incomes are uncertain. The fourth is that taxes are not lump sum, since they depend typically on income, spending wealth, and so on. The fifth is that the Ricardian result hinges on full employment. I assume throughout that the path of government spending is given. The Ricardian analysis applies to shifts in budget deficits and taxes for a given pattern of government expenditures; in particular, the approach is consistent with real effects from changes in he level or timing of government purchases and public services In many cases it turns out that budget deficits matter, and are in that sense non-Ricardian. It is important, however, to consider not only whether the ricardian view remains intact, but also what alternative conclusions emerge. Many economists raise points that invalidate strict Ricardian equivalence, and then simply assume that the points support a specific alternative; usually the standard view that a budget deficit lowers desired national saving and thereby drives up real interest rates or leads to a current-account deficit. Many criticisms of the Ricardian position are also inconsistent with this standard view Finite horizons and related Issues The idea of finite horizons, motivated by the finiteness of life, is central to life-cycle models--see, for example, Franco Modigliani and Richard Brumberg (1954)and Albert Ando and Franco Modigliani(1963). In these models individuals capitalize only the taxes that they expect to face before dying. Consider a deficit- financed tax cut, and assume that the higher future taxes occur partly during the typical persons expected lifetime and partly thereafter. Then the present value of the first portion must fall short of the initial tax cut, since a full balance results only if the second portion is included. Hence the net wealth of persons currently alive rises and households react by increasing consumption demand. Thus, as in the standard approach sketched above, desired private saving does not rise by enough to offset fully the decline in government saving A finite horizon seems to generate the standard result that a budget reduces desired national saving. The argument works, however, only if the typ person feels better off when the government shifts a tax burden to his or her tndants. The argument fails if the typical person is already giving to his or her children out of altruism. In this case people react to the government's imposed intergenerational transfers, which are implied by budget deficits or social security, with a compensating increase in voluntary transfers(Barro, 1974). For example parents adjust their bequests or the amounts given to children while the parents are still living. Alternatively, if children provide support to aged parents, the amounts given can respond(negatively) to budget deficits or social security. The main idea is that a network of intergenerational transfers makes the typical person a part of an extended family that goes on indefinitely. In this setting, households capitalize the entire array of expected future taxes, and thereby plan effectively with an infinite horizon. In other words, the ricardian results, which