The Ricardian equivalence theorem states that
A) an increase in government spending has no effect on aggregate supply.
B) increases in government spending have a larger impact on real Gross Domestic Product (GDP) than decreases in taxes.
C) an increase in the government budget deficit created by a current tax cut has no effect on aggregate demand.
D) an increase in the government budget deficit has no effect on real Gross Domestic Product (GDP) because it only affects the price index.

Question

Quizplus · Accepted Answer

The Ricardian equivalence theorem suggests that individuals anticipate the future tax obligations resulting from a current increase in government borrowing to finance a tax cut, and therefore adjust their behavior in anticipation of future taxes. This means that the increase in government borrowing has no effect on aggregate demand, as the increase in consumer spending resulting from the tax cut is offset by an increase in savings to pay for future taxes.

The Ricardian Equivalence Theorem States That