...think about what happens when a family buys a house with a 30-year mortgage.So, according to Paul, "Ricardian Equivalence," which is the theorem that stimulus does not work in a well-functioning economy, fails, because it predicts that a family who takes out a mortgage to buy a $100,000 house would reduce consumption by $100,000 in that very year.
Suppose that the family takes out a $100,000 home loan .... If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt.
But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase.
How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong?How indeed?
The answer is, we didn't, and Paul got this one wrong.