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Lecture 151 Macroeconomic Analysis 2003 Fiscal Policy 2: Ricardian Equivalence Theorem And Inflation Tax.

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Presentation on theme: "Lecture 151 Macroeconomic Analysis 2003 Fiscal Policy 2: Ricardian Equivalence Theorem And Inflation Tax."— Presentation transcript:

1 Lecture 151 Macroeconomic Analysis 2003 Fiscal Policy 2: Ricardian Equivalence Theorem And Inflation Tax

2 Lecture 152 Contents Main point of the Ricardian Equivalence Theorem (RET) Graphical and Algebraic Illustration of RET Numerical Example of RET Limitations of RET Deficit financing by printing money:Seigniorage Optimal Inflation tax rate Why governments like inflation tax? Dangers of excessive inflation

3 Lecture 153 Ricardian Equivalence: Main Proposition How important is a tax cut? Should government finance deficit by borrowing or by raising taxes? Ricardian Equivalence Theorem is after David Ricardo. British economist, who wrote about 180 years ago that it does not matter whether government finances its deficit by borrowing or taxes.

4 Lecture 154 Ricardian Equivalence: Main Proposition If it borrows now it raises tax in future for repayment of its debt. With more current debt private households save more in anticipation of higher taxes in the future that government will impose on them to repay the debt. Private households optimise intertemporally and completely internalise public policy. Borrowing only or tax only strategy does not matter if both the government and household honour their own inter temporal budget constraints.

5 Lecture 155 Basic Proposition of the Ricardian Equivalence Tax or Borrowing Does not Make Any Difference C1 C2 Before Borrowing Budget Constraint After borrowing budget constraint Today Tomorrow

6 Lecture 156 Model Economy for Ricardian Equivalence Theorem

7 Lecture 157 Tax Spending and Borrowing Strategies

8 Lecture 158 Optimisation for Ricardian Equivalence Theorem

9 Lecture 159 Conclusion of the Ricardian Equivalence Theorem

10 Lecture 1510 Numerical Proof of Ricardian Equivalence Theorem -1

11 Lecture 1511 Borrowing strategy: period 1 borrowing of 30

12 Lecture 1512 Limitations of Ricardian Equivalence Theorem

13 Lecture 1513 Deficit Financing by Printing Money

14 Lecture 1514 Inflation Tax: A Numerical Example

15 Lecture 1515

16 Lecture 1516

17 Lecture 1517 Exercises Does it make difference if the deficit if financed by more taxes or by more borrowing? Proof of Ricardian Equivalence Household utility with and without public goods Implications of borrowing from the private sector or the central bank How does inflation tax reduce the debt burden for governments?


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