Ricardian Equivalence

Cochrane and the other economists of his school believe that Keynes has been refuted, and that stimulatory spending via government deficits can't work. Their principal justification is Ricardian Equivalence - which to Cochrane is a sacred "theorem". His reasoning is tautolgical:

it's a logical connection from a set of "if" to a set of "therefore." Not even Paul can object to the connection.

"If" frogs had fur, "then" the world could be made safe for chinchillas.

There are a few things you need to know about Ricardian equivalence and Barro's "proof" of the same. Let Wikipedia explain:

In simple terms, the theory can be described as follows. Governments may either finance their spending by taxing current taxpayers, or they may borrow money by issuing bonds. In the latter case, they must eventually repay this borrowing by raising taxes above what they would otherwise have been in future. The choice is therefore between "tax now" and "tax later".

Suppose that the government finances some extra spending through deficits - i.e. tax later. Ricardo argued that although taxpayers would have more money now, they would realize that they would have to pay higher tax in future and therefore save the tax cut in order to pay the future tax rise. The effect on demand would be exactly the same as if the government financed its saving through taxes.

The first important thing to know is that Ricardo, who was a very clever fellow, didn't believe it.

In "Essay on the Funding System" (1820) Ricardo studied whether it makes a difference to finance a war with the £20 million in current taxes or to issue government bonds with infinite maturity and annual interest payment of £1 million in all following years financed by future taxes. At the assumed interest rate of 5%, Ricardo concluded that "In point of economy there is no real difference in either of the modes, for 20 millions in one payment, 1 million per annum for ever ... are precisely of the same value". However, Ricardo himself was skeptical about the empirical validity of this equivalence. He continued: "but the people who paid the taxes never so estimate them, and therefore do not manage their private affairs accordingly. We are too apt to think that the war is burdensome only in proportion to what we are at the moment called to pay for it in taxes, without reflecting on the probable duration of such taxes. It would be difficult to convince a man possessed of £20,000, or any other sum, that a perpetual payment of £50 per annum was equally burdensome with a single tax of £1000".[1] In other words, if people had rational expectations they would be indifferent between the two systems, but since they do not have them, they are subjected to a "fiscal illusion", which distorts their decisions.

Fast forward 150 years and Robert Barro comes up with his celebrated (and maligned) "proof". There are one or two things you ought to know about his proof. First, it's based on two assumptions that are manifestly untrue.

This model assumes that families act as infinitely lived dynasties because of intergenerational altruism, capital markets are perfect (meaning that all can borrow and lend at a single rate)...

There are a few other details left out too, e.g. economic growth. In any other subject which pretended to be a science, such a proof would be laughed off the stage, but economics, or at least the freshwater version, is funny that way.