When Ricardian equivalence holds,a tax cut:
A) increases aggregate demand in the long run.
B) increases aggregate demand in the short run.
C) doesn't decrease aggregate demand even in the long run.
D) doesn't increase aggregate demand even in the short run.

Question

Quizplus · Accepted Answer

Ricardian equivalence suggests that individuals understand that a tax cut today will eventually lead to either higher taxes or lower government spending in the future in order to pay off the resulting government debt. Therefore, individuals save their tax cut rather than spend it, which means that aggregate demand is not increased even in the short run. Hence, a tax cut doesn't increase aggregate demand even in the short run if Ricardian equivalence holds.

When Ricardian Equivalence Holds,a Tax Cut