The fallacy of Ricardian equivalence

from Asad Zaman

Stiglitz: Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense  [see “Quotes Critical of Economics” for more.] This post explains why.

In this post, we will create a simple model that demonstrates some fundamental truth of Modern Monetary Theory.  This is a variant of “.Simple Model Explains Complex Keynesian Conceptss“, We will show the following phenomena

1. A Market Economy naturally creates an equilibrium with high unemployment and under-employment, showing existence of under-employment equilibria
2. Government Deficit Spending increases aggregate demand, and moves the economy to full employment.
3. Deficit Spending, also massively improves social welfare, by providing food even to the unemployed, using the additional output created by the increased aggregate demand
4. Deficit Spending is not  “FINANCED” from any source. Government spending money which it does not have, creates welfare by injecting money into the economy. This money leads to increased output and is not inflationary. The government can continue this deficit spending forever, without worrying about sustainability or “paying back” the debt.
5. Government Deficit injects money into the system which is exactly equal to the PROFITS of the firms, plus the SAVINGS of the laborers. Since firms work for profits while households wish to save, neither can succeed UNLESS the government runs deficits. Thus deficit spending is crucial to a capitalist economy — without it there would be no profits for business, and without profits and savings the economy would collapse.   Read more