If government spending is held constant and Ricardian equivalence holds,
A) an increase in the government budget deficit is always matched by a reduction in private savings.
B) an increase in government savings is always matched by an increase in the government budget deficit.
C) an increase in government savings is always matched by an equal increase in private savings.
D) an increase in government savings is always matched by an equal reduction in private savings.
E) an increase in government savings is always matched by an increase in the real interest rate.

Question

Quizplus · Accepted Answer

If government spending is held constant, an increase in government savings (which is the opposite of a budget deficit) means that the government is collecting more in taxes than it is spending. According to Ricardian equivalence, individuals will perceive this as a reduction in the tax burden on future generations and will save less in response. Therefore, there will be an equal reduction in private savings to match the increase in government savings. This means that Choice D is the correct answer.

If Government Spending Is Held Constant and Ricardian Equivalence Holds