GOVERNMENT DEBT, LIFE-CYCLE INCOME, AND LIQUIDITY CONSTRAINTS - BEYOND APPROXIMATE RICARDIAN EQUIVALENCE

Evans (1991) has demonstrated that Blanchard's (1985) finite-horizon m odel obeys approximate Ricardian equivalence. This paper shows that th is result is determined largely by an unrealistic assumption that labo r income grows monotonically over rite consumer's entire lifetime. Wit h more realistic lifetime earnings profiles, the effects of government debt on the real interest rate and the capital stock are considerably larger. Iii particular, leaving aside the effects of distortionary ca pital taxation, the extended model with liquidity constraints predicts that real inter est rates would decline by about 150-200 basis points if government debt were eliminated completely in all countries of the Organization for Economic Cooperation and Development (OECD).