What Is Ricardian Equivalence?

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[Narrator] What is
Ricardian equivalence?

Named after David Ricardo --
a 19th-century British economist --

Ricardian equivalence is a scenario

in which consumers respond
to changes in fiscal policy

in ways that make
fiscal policy less effective.

If the government cuts taxes
to stimulate the economy,

people might then choose
to save the tax cut

instead of spending it.

Now, saving money from a tax cut
actually makes a lot of sense

if people expect that tax cuts today

will be matched
by tax increases tomorrow.

However, if people save
their tax cuts

instead of spending them,

then the aggregate demand curve
never shifts out,

the multiplier will be zero,

and there will be no systematic
macroeconomic effects.

Most economists think
Ricardian equivalence is imperfect

and that it's somewhat unrealistic
to model everyone as fully rational

in incorporating
their future tax burdens

when making saving
and spending decisions.

So, Ricardian equivalence
probably describes some people --

maybe not most people.

In any case, to the extent
that Ricardian equivalence

reflects how people plan,

tax cuts will be less effective
as fiscal stimulus

than they otherwise would be.

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of implementing fiscal policy,

click here.

Or, test your knowledge
on Ricardian equivalence here.

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