Question

The proposition that increases in the government budget deficit has no effect on aggregate demand is called the

Answer 1

The proposition that increases in the government budget deficit has no effect on aggregate demand is called the Ricardian Equivalence Theorem.

What is Ricardian Equivalence Theorem?

• 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.

Therefore, The proposition that increases in the government budget deficit has no effect on aggregate demand is called the Ricardian Equivalence Theorem.

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