What Is the Ricardian Equivalence Theorem and Why Is It

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The Answer is David Ricardo's Ricardian Equivalence Theorem stated that government spending financed by selling government bonds (the government running a budget deficit)was no different from government spending financed by taxes (the government running a balanced budget).Government would have to increase taxes in the future both to pay the interest on the bonds and to repay the bonds when they came due.Assuming people can borrow and save,and thereby shift spending between now and the future,people would save more now to pay for those future taxes.So,there is no reason why deficit financed spending should affect the aggregate level of income differently than tax financed spending.It followed that a government deficit would not lead to an expansion of output in the economy.This theoretical proposition that deficits do not affect the level of output in the economy because individuals will increase their savings to account for expected future tax payments to repay the deficit has become known as the Ricardian Equivalence Theorem.
Based on Ricardian equivalence,some have argued that whether a government deficit is financed by bonds (deficit spending)or by taxes (balanced budget)is irrelevant.The method of funding government spending does not affect aggregate output.

What Is the Ricardian Equivalence Theorem and Why Is It

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