Therefore mt t and mt t recall the governments budget

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Unformatted text preview: t t and future period t . Therefore mt = T and mt = T . Recall the government’s budget constraint: G + G / (1+r) = T + T /(1+r) Using the definition stated above we can write this as: G + G / (1+r) = m[ t + t /(1+r) ] Now here’s the trick to understanding Ricardian equivalence. It only deals with tax changes – Not changes in government expenditure. Therefore the level of government expenditure is GIVEN. important So that G and G are some given amounts. Now suppose the government changes TAXES in the current period. Without ANY CHANGE in expenditure this means that second period taxes will have to change so the government’s budget constraint is satisfied. Thus: t = - t /(1+r) t = -(1+r) t This means that any tax change in the present period will be matched by an opposite tax change in future –one that INCLUDES interest payments!!! Recall the consumer’s budget constraint: c + c /(1+r) = y + y /(1+r) – [ t + t (1+r)] Now with no change in GOVERNMENT SPENDING the present value of taxes, [ t + t (1+r)] will not change present changes are matc...
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