Krugman's Evidence for Ricardian Equivalence
By David Henderson
Paul Krugman has been an outspoken critic of Ricardian Equivalence, David Ricardo’s idea, revived by Robert Barro in 1974, that, holding government spending constant, when the government cuts taxes and increases deficits, people will save more to pay the inevitably-higher taxes down the road.
But Krugman’s latest blog post gives some crude indirect evidence for this. Referencing a McKinsey Global Institute Report, he shows that as U.S. governments have increased debt as a % of GDP (by 19 percentage points), the private sector (households and non-financial corporations) have reduced their debt by virtually the same percent of GDP (18 percentage points). He argues plausibly that financial sector debt should be ignored.
Of course, over that time period, government spending has not been held constant but has spiked up. Still, it seems that a crude test for Ricardian equivalence is whether increases in government debt are offset by declines in private debt. I’m not Mr. Macro, and so I could be missing something subtle or even obvious, but this evidence seems quite striking.