Income Uncertainty and Ricardian Equivalence
Abstract
This note characterizes the nature of Ricardian-equivalence failure when either the old generation's or the young generation's income is uncertain and the nonnegativity constraint on bequests is binding in some states of nature. Assuming a positive third derivative of the utility function, the same condition needed for precautionary savings,' it is shown that the degree of failure of Ricardian equivalence is greater when the corner has to do with parental poverty than when the corner has to do with children's wealth. The reason is that in corners associated with parental poverty (and therefore lower parental consumption) marginal utility is more sensitive to extra consumption, leading to a higher marginal propensity to consume in the first period. Consequently, government transfers cause a substantial reduction of precautionary savings in poor corners, in contrast to rich corners, where precautionary savings are only slightly affected.
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