Deadweight Losses and the Saving Response to a Deficit.

Several recent empirical studies have challenged the conventional wisdom that deficits cause a higher interest rate. Many economists are, however, critical of the seemingly implied theoretical justification--that every individual fully recognizes the size of the deficit and the extent to which it increases future tax liabilities. This paper demonstrates that far weaker information assumptions are needed to obtain an aggregate savings response equal to the deficit: a reallocation of deadweight losses causes Ricardians to save more than their share of the deficit to keep consumption unaffected, allowing for a substantial fraction of Keynesians who save less than their share. Copyright 1989 by Oxford University Press.