The decrease in taxes and an increase in debt leave each taxpayer with more cash or bonds but with property diminished in net market value by a like amount, so that his net worth is unchanged. Ricardian equivalence is complete, and the stimulative effect is limited to a relatively minor liquidity effect; there may also be a saving of interest if the public debt bears a lower interest rate than private obligations. And if public debt is incurred to finance outlays on infrastructure or other features that enhance land rentals, there will be a substantial stimulative effect. These activities would then attract an added share in the burden of servicing the debt. At low debt levels, the hope may persist that other investors will come along to take up some of this burden, but at some point this bubble of hope may vanish rather suddenly, with catastrophic results.
This effect may be mitigated to some extent if the debt is incurred to finance infrastructure that enhances property values. In most cases, however, even if investment in improvements continues unabated, if the debt is financed by taxes on improvements, the investment will fall short of what would take full economic advantage of the increased productivity generated by the public investment. Proposition 3: National deficits still stimulateAt the U.S. federal level, with heavy reliance on taxes based on earnings (or on consumption), deficit financing shifts tax burdens from present earning effort and consumption to burdens on future earnings and consumption, without capitalization in reduced asset values. Thus, current consumption and income production are encouraged, especially since, for many, the future burden, if any, will be beyond their horizon. The result is a strong stimulative effect. Proposition 4: Fallacious beliefs can be temporarily self-justifying.
Nevertheless, if a sufficiently strongly held belief prevails in Ricardian equivalence or its close relative the "crowding out" theory, this may for a time hold back investment sufficiently to outweigh the stimulus to consumption, and thus become, for a time, a self-fulfilling prophecy. Agents are people, not robots imbued with an "irrational passion for dispassionate rationality" in the single-minded pursuit of net profits. And even for those not seized with the "crowding-out" fallacy, it would be irrational not to take account of the irrational reactions of others. Eventually, however, this must succumb to the realities of increased disposable income and market demand.
Having posted these caveats, we can now turn to the core of Keynesian analysis as it applies to the contemporary situation.
For the industrialized world as a whole, and for most of its constituent countries individually, it has become impossible, for the foreseeable future, to achieve sustained adequately full employment without large and growing government debts and corresponding budget deficits. On the one hand, increased longevity and duration of retirement, higher...