DP7792 Does Ricardian Equivalence Hold When Expectations are not Rational?

Author(s): George W. Evans, Seppo Honkapohja, Kaushik Mitra
Publication Date: April 2010
Keyword(s): expectations, Ramsey model, Ricardian equivalence, Taxation
JEL(s): D84, E21, E43, E62
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7792

This paper shows that the Ricardian Equivalence proposition can continue to hold when expectations are not rational and are instead formed using adaptive learning rules. In temporary equilibrium, with given expectations, Ricardian Equivalence holds under the standard conditions for its validity under rational expectations. Furthermore, Ricardian Equivalence holds for paths of temporary equilibria under learning provided suitable additional conditions on learning dynamics are satisfied. New cases of failure of the Ricardian proposition emerge under learning. Most importantly, agents' expectations must not depend on government's financial variables under deficit financing.