An increase in government spending will have no effect on real GDP if
A) people look at changes in taxes only in the present.
B) there is no crowding out.
C) the Ricardian equivalence theorem holds.
D) the tax decrease is offset by an increase in government spending.

Question

Quizplus · Accepted Answer

According to the Ricardian equivalence theorem, an increase in government spending will have no effect on real GDP because individuals are forward-looking and will adjust their saving behavior in anticipation of future tax increases to repay the government debt. Essentially, they recognize that the government spending increase will need to be financed through either taxes or borrowing, which will have a negative effect on their future disposable income. As a result, they save more in the present to offset the expected future tax burden, which means that there is no increase in consumption or investment demand to stimulate real GDP. Therefore, the correct answer is C.

An Increase in Government Spending Will Have No Effect on Real