Which of the following provides the clearest statement of the Ricardian equivalence theorem?
A) Both an increase in government expenditures and a reduction in taxes will provide a substantial stimulus for aggregate demand.
B) When additional debt is used to finance a tax cut, the lower taxes and higher interest rates will exert an equivalent impact on aggregate demand.
C) The finance of government spending with additional debt is essentially the same thing as finance with higher taxes because the larger debt implies higher taxes in the future.
D) A 10 percent reduction in tax rates will reduce tax revenues by 10 percent.

Question

Quizplus · Accepted Answer

The Ricardian equivalence theorem states that the way a government finances its spending does not affect the overall level of demand in the economy. Choice C provides the clearest statement of this by saying that additional debt is essentially the same thing as higher taxes because the larger debt implies higher taxes in the future. This suggests that individuals will realize that they will have to pay higher taxes in the future to pay off the debt and will therefore save more now to prepare for those higher taxes, meaning that demand remains unchanged. None of the other choices provide as clear a statement of the Ricardian equivalence theorem.

Which of the Following Provides the Clearest Statement of the Ricardian