A common argument from conservative economists is that stimulus measures never work because citizens price in future tax increases and thus choose to hoard instead of to consume. In other words, because people know that easy money will eventually have to be paid for through future tax hikes, they hold on to the money instead of spending it on consumer goods. This argument is known as Ricardian equivalence. A number of neo-Keynesians have convincingly argued against this both empirically and theoretically. First, as Mark Blyth points out, very few consumers are as rational and pragmatic as most economic models assume. In fact, I would be surprised if any of my friends and family seriously think about future tax rates when visiting the supermarket. It is simply too uncertain and too abstract for people to grapple with on a daily basis. People certainly react to tax hikes and tax cuts, but it seems very improbable that they meaningfully change their consumption levels simply due to the possibility of some unspecified change in tax policy at some point in the future. Second, Ricardian equivalence forgets that increases in taxes can be implemented gradually, and future generations can be taxed as well. Thus, an individual does not necessarily have to cover the tax breaks she received. And, even if she does, it is likely that she will be paying them back in small increments over many years, which is hardly the kind of economic burden that would engender hoarding. Furthermore, if effective fiscal and monetary policy succeeds in dampening economic volatility and expanding the overall economy, tax rates might not need to increase by as much as predicted to cover earlier government spending.
Ricardian equivalence is, therefore, a stupid extrapolation from overly simplistic models. However, what I find particularly hilarious is that the same Austrian economists who assume that hyper-rational consumers will factor in future tax hikes also argue that investors are irrational when it comes to the banking system. Indeed, the standard Austrian explanation for why financial crises occur is that the money supply is artificially increased to unsustainable rates. By keeping interest rates artificially low, this excessive money supply overheats the economy and helps generate bubbles that, sooner or later, burst. Different models emphasize different reasons for this (some focus on the central bank while others focus on the banking system as a whole). But what virtually every model agrees on is that deliberate action by the banking system can trick investors into acting in ways that are not economically efficient.
This doesn’t make any sense if Ricardian equivalence is also true. After all, hyper-rational investors should know that there is something fishy about interest rate levels and suspect a bubble is forming. This very rarely happens, though, as the many financial crises throughout history demonstrate. Thus, it is not hard to imagine that government spending, tax cuts, and looser monetary policy do, in fact, have an impact on people’s consumption levels. If people can be tricked into creating bubbles, they can also be tricked into maintaining their consumption during economic downturns. In other words, one cannot simultaneously maintain that government actions can distort economic behavior in deleterious ways while also arguing that governments cannot take actions that influence economic behavior in positive ways. Consumers and investors cannot be stupid half of the time and then brilliant and forward-thinking the other half of the time. Ricardian equivalence is nothing more than politically motivated nonsense employed by people on the right wing of the political spectrum who believe that any government intervention in the economy is a bad idea, and it blatantly contradicts other aspects of conservative economic theory. Unfortunately, it’s an argument that will keep being made, and many policymakers will continue to believe it.