THE MODERN RICARDIAN EQUIVALENCE THEOREM: DRAWING THE WRONG CONCLUSIONS FROM DAVID RICARDO’S ANALYSIS

Abstract

The modern Ricardian equivalence theorem focuses on the intertemporal equivalence between taxation and bond financing of government expenditures that David Ricardo considered practically irrelevant, rather than their contemporaneous equivalence in terms of the opportunity cost of government spending. Relying upon the implausible assumption of each individual’s future tax-capitalization behavior that Ricardo explicitly rejected, the modern Ricardian equivalence theorem reaches the exact opposite conclusions about government deficit spending than Ricardo argued. This paper explains these fundamental problems with the modern Ricardian equivalence proposition and shows an alternative method of arguing Robert Barro’s original point about the inefficacy of Keynesian deficit spending.