Ricardian Equivalence

AAA

DEFINITION of 'Ricardian Equivalence'

An economic theory that suggests that when a government tries to stimulate demand by increasing debt-financed government spending, demand remains unchanged. This is because the public will save its excess money in order to pay for future tax increases that will be initiated to pay off the debt. This theory was developed by David Ricardo in the nineteenth century, but Harvard professor Robert Barro would implement Ricardo's ideas into more elaborate versions of the same concept.

Also known as "Barro-Ricardo equivalence proposition"

INVESTOPEDIA EXPLAINS 'Ricardian Equivalence'

The basic idea behind Ricardo's theory is that no matter how a government chooses to increase spending, whether with debt financing or tax financing, the outcome will be the same and demand will remain unchanged. The major arguments against Ricardo's theory are due to the unrealistic assumptions on which the theory is based, such as the assumptions of the existence of perfect capital markets, the ability for individuals to borrow and save whenever they want, and the assumption that individuals will be willing to save for a future tax increase even though they may not see it in their lifetimes. Furthermore, the theory provided by Ricardo goes against the more popular theories provided by Keynesian economics.

RELATED TERMS
  1. Fiscal Policy

    Government spending policies that influence macroeconomic conditions. ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects ...
  3. Taxes

    An involuntary fee levied on corporations or individuals that ...
  4. Debt Financing

    When a firm raises money for working capital or capital expenditures ...
  5. Demand Shock

    A sudden surprise event that temporarily increases or decreases ...
  6. Separation Of Powers

    An organizational structure in which responsibilities, authorities, ...
RELATED FAQS
  1. What is the Ricardian vice?

    The Ricardian vice refers to abstract model-building and mathematical formulas with unrealistic assumptions. In simpler terms, ... Read Full Answer >>
Related Articles
  1. Economics

    Economics Basics

    Learn economics principles such as the relationship of supply and demand, elasticity, utility, and more!
  2. Options & Futures

    Explaining The World Through Macroeconomic Analysis

    From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone.
  3. Retirement

    Economic Indicators To Know

    The economy has a large impact on the market. Learn how to interpret the most important reports.
  4. Economics

    Are Greece’s Worries Almost Over?

    Last week ended with the news that Greece and the European Union (EU) finance ministers struck a deal to temporarily extend the Greek bailout program.
  5. Economics

    Why Is Ukraine At War? A Russian Rivalry With West

    Huge power games which are being played behind the Ukrainian conflict are rooted in a previous revolution, a past Cold War, and an old Russia-West rivalry.
  6. Economics

    Does A Junk Rating Reflect Russia's Fundamentals?

    Moody’s, like other credit rating agencies, has downgraded Russia’s sovereign debt rating to non-investment grade, but does this reflect Russia's economy?
  7. Economics

    This Is A Small Country With Huge Potential to Grow

    Trinidad and Tobago's increased revenue and economic success have been primarily generated by its energy sector, but it still might be best to diversify.
  8. Economics

    Popular Places Where U.S. Citizens Need A Visa

    A U.S. passport will get you into many countries, but not everywhere. Here's how to visit five of the most popular destinations that require visas.
  9. Economics

    What's a Subsidy?

    A subsidy is a benefit given to an individual, business or institution, typically by the government. Subsidies are given to promote a social good or an economic policy. The government usually ...
  10. Economics

    How To Pass The U.S. Citizenship Test

    The U.S. citizenship test includes a civics section some states may require high school grads to master. Here's what an immigrant must know to pass it.

You May Also Like

Hot Definitions
  1. Fixed Cost

    A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses ...
  2. Subsidy

    A benefit given by the government to groups or individuals usually in the form of a cash payment or tax reduction. The subsidy ...
  3. Sunk Cost

    A cost that has already been incurred and thus cannot be recovered. A sunk cost differs from other, future costs that a business ...
  4. Technical Skills

    1. The knowledge and abilities needed to accomplish mathematical, engineering, scientific or computer-related duties, as ...
  5. Prepaid Expense

    A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received ...
  6. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. ...
Trading Center