Question

Suppose you are analyzing data for an economy in which Ricardian neutrality holds true. If the budget deficit increases by 50, then:

Answer 1

While analyzing data if Ricardian neutrality holds true then the budget deficit increases by 50, then private savings will increase by 50.

Ricardian Equivalence

• According to the economic principle known as Ricardian equivalence, paying government expenditures with current taxes or future taxes (as well as current deficits) will have similar impacts on the overall state of the economy.
• Therefore, increased government expenditure that is financed by debt will not be able to stimulate the economy since investors and consumers are aware that the loan would eventually need to be repaid through future taxes.
• The hypothesis contends that consumers will save because they anticipate paying higher taxes in the future to reduce the debt, which will counteract the rise in aggregate demand brought on by higher government spending.
• This suggests that Keynesian fiscal policy will typically fail to increase economic growth and output.

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