How Ricardian Are We?

Not very. To answer this question, we conjecture that households might be non-Ricardian because they do not have rational expectations over their future tax burden. From this assumption, we derive a behavioral consumption function, where households act as if bonds are net wealth and consume out of taxes and transfers. The coefficient on taxes is determined by the attenuation present in households’ behavioral expectations. This consumption function also nests other causes of non-Ricardianism, including liquidity constraints and overlapping generations. To estimate the coefficient, we derive a Bayesian limited information method that uses a large number of macroeconomic shocks from the literature as instrumental variables. We find that households internalize only one-fifth of their future taxes. In a general equilibrium model, this low value implies that public borrowing substantially crowds out private investment