Question

Discuss four reasons why the Ricardian equivalence proposition​ isn't likely to hold exactly.

Answer 1

The Ricardian equivalence proposition suggests that rational individuals may adjust their saving behavior in response to changes in government borrowing. However, there are several reasons why this theory may not hold exactly, including uncertainty about future tax rates, incomplete credit markets, different time horizons, and behavioral factors.

Step-by-step explanation:

The Ricardian equivalence proposition suggests that rational individuals may adjust their saving behavior in response to changes in government borrowing. However, there are several reasons why this theory may not hold exactly:

1. Uncertainty about future tax rates: Rational individuals may be uncertain about future tax rates and therefore may not respond to changes in government borrowing in the way predicted by Ricardian equivalence.
2. Incomplete credit markets: If individuals do not have access to credit markets or face borrowing constraints, they may not be able to easily offset changes in government borrowing through their own saving behavior.
3. Different time horizons: Government borrowing and individuals' saving decisions may have different time horizons. Individuals may make short-term saving decisions while government borrowing can have long-term effects.
4. Behavioral factors: People may not always make rational economic decisions. Psychological factors and behavioral biases can influence saving behavior, making it difficult to rely on the assumptions of Ricardian equivalence.