Intellectual capital explanation
I Figured Out What Scott Sumner Is Talking About « Uneasy Money: Paul Krugman and Simon Wren-Lewis pounced on this assertion, arguing that Ricardian equivalence actually reinforces the stimulative effect of government spending financed by taxes, because consumption smoothing implies that a temporary increase in taxation would cause current consumption to fall by less than would a permanent increase in taxation…. Now this response by Krugman and Wren-Lewis was just a bit opportunistic and disingenuous, the standard explanation for a balanced-budget multiplier equal to one having nothing to do with the deferred effect of temporary taxation. Rather, it seems to me that Krugman and Wren-Lewis were trying to show that they could turn Ricardian equivalence to their own advantage…
This seems to me to be wrong.
Suppose that there is no consumption smoothing and no balanced-budget multiplier: that households have a target level of savings independent of their income and wealth, so that raising their taxes by $1 leads them to cut back the present value of consumption spending not by $(1-s) but by the full $1. So that with no consumption smoothing there is no balanced-budget multiplier.
But now add consumption smoothing. This period's government purchases go up by $1. This period's private consumption spending goes down by $r. There is a short-term stimulative effect of fiscal policy even without a balanced-budget multiplier...
Source: Brad DeLong
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