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

Ricardian equivalence suggests that individuals may anticipate future tax increases to pay for current deficit spending and adjust their behavior accordingly, such as saving more to offset the future tax burden. Therefore, if government spending is held constant, an increase in government savings (which reduces the budget deficit) would imply an expected future tax cut, which would motivate individuals to reduce their savings to take advantage of the tax cut. Hence, an increase in government savings is always matched by an equal reduction in private savings.

If Government Spending Is Held Constant and Ricardian Equivalence Holds