Abstract

Government Debt as a Reason for Lacking Neutrality

A Contribution to the Ricardian Equivalence Theorem

While Barro did in fact prove the validity of the Ricardian equivalence theorem for making positive bequests, he was, however, in no position to define under what circumstances a motive for bequests actually exists. Since private individuals “respond” to increased government debt by increasing the legacies they hand down, it is evident that the very level and, consequently, actual bequests depend on the level of government borrowing. If the level of government debt falls short of a certain limit, it turns out that – although there is a motive for handing down legacies – actual bequests are not made. This means that government is in a position to determine through the level of its borrowings whether a motive for bequests actually materializes. In other words, the Ricardian equivalence theorem is a function of the level of government borrowing. If government adopts a rate of borrowing that reduces the handing down of legacies to about nil, the result is an undercapitalized steady state. In order to arrive at the golden rule of capital accumulation, there is a need for forced capital formation. It is impossible to counteract the lowering of the level of government borrowing by adequately reducing bequests because of the fact that bequests are actually not made in spite of an existing motive therefore, which means that this policy generates the desired results. Since bequests are consequently not made in the pareto-optimal steady state, optimum fiscal policies are independent of an existing motive for making bequests. It is identical with the one contained in the model precluding the motive for making bequests