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Chapter 18: Q.21 (page 451)

Explain whether or not you agree with the premise of the Ricardian equivalence theory that rational people might reason: 鈥淲ell, a higher budget deficit (surplus) means that I鈥檓 just going to owe more (less) taxes in the future to pay off all that government borrowing, so I鈥檒l start saving (spending) now.鈥� Why or why not?

Short Answer

Expert verified

Difficult to agree with the statement.

Step by step solution

01

Definition

Budget Deficit:

A budget deficit is described as a situation in which the government's revenues fall short of its expenses. Increased taxes, lower government expenditure, and increased economic growth can all help to reduce the government's budget deficit.

02

Explanation

Ricardian equivalence assumes economic agents to be completely rational and expects them to understand that any increase in deficit-financed government expenditure will eventually necessitate greater taxes to pay off the debt.

03

Explanation

Difficult to agree with the statement mentioned in the question because people do not have the insight to save for the future instead of spending now. It's possible that people won't be able to just save at this moment. They don't always have control over when and how much they save or spend. They may not be able to foresee whether present tax cuts may lead to future tax hikes..

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Most popular questions from this chapter

The U.S. government has shut down a number of times in recent history. Explain how a government shutdown will affect the variables in the national investment and savings identity. Could the shutdown affect the government budget deficit?

Illustrate the concept of Ricardian equivalence using the demand and supply of financial capital graph.

During the most recent recession, some economists argued that the change in the interest rates that comes about due to deficit spending implied in the demand and supply of financial capital graph would not occur. A simple reason was that the government was stepping in to invest when private firms were not. Using a graph, explain how the use by the government in investment offsets the deficit demand.

How would you expect larger budget deficits to affect private sector investment in physical capital? Why?

Describe how a plan for reducing the government deficit might affect a college student, a young professional, and a middle-income family.
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