Question

Ricardian equivalence and the government budget constraint: Consider the intertemporal budget constraint in equation (18.5). Assume the interest rate is i.

What economic concept or principle is likely being discussed in the context of Ricardian equivalence and the government budget constraint?
a) Fiscal policy
b) Monetary policy
c) Inflation targeting
d) Rational expectations

Answer 1

Ricardian equivalence is a theory that suggests rational private households may adjust their saving to offset government saving or borrowing. This theory implies that changes in government borrowing will not affect physical capital investment or trade balances.

Step-by-step explanation:

Ricardian equivalence refers to the theory that rational private households may adjust their saving to offset government saving or borrowing. According to this theory, any change in budget deficits or surpluses would be completely offset by a corresponding change in private saving. This means that changes in government borrowing would have no effect on physical capital investment or trade balances. In the context of the intertemporal budget constraint, Ricardian equivalence suggests that changes in government borrowing will not affect the overall saving and investment identity.