CFA Level I · CFA Level I Exam · Fiscal Policy
An economist argues that households will respond to a debt-financed tax cut by saving the extra income, because they expect higher taxes in the future to repay the debt. This argument is best described as:
This is Ricardian equivalence. Forward-looking households see that debt-financed tax cuts imply higher future taxes, so they save the windfall rather than spend it, which offsets the deficit and limits the stimulus the tax cut was intended to provide.
- ARicardian equivalenceCorrect
- Bthe liquidity trap
- Cthe multiplier effect
Explanation
Ricardian equivalence holds that rational consumers offset the government's deficit by saving more, anticipating future taxes. This weakens the stimulative effect of debt-financed tax cuts. The multiplier effect and liquidity trap do not describe this behavior.
Did you get it right without looking?
One question tells you little. A timed set on Fiscal Policy shows your real accuracy, how long you take and where you lose marks.
More Fiscal Policy questions
- An economy is in a deep recession with high unemployment. Policymakers want a fiscal stimulus with the fastest and largest effect on aggrega…
- An economy has a debt-to-GDP ratio of 80%. Nominal GDP is growing at 4% a year and the government pays an average interest rate of 3% on its…
- Compared with an equal-sized change in government spending, a change in personal income taxes is most likely to have a smaller initial effec…
- Compared with an otherwise identical economy, the fiscal multiplier for a given increase in government spending is most likely smaller when …
- An economy is operating above potential GDP and inflation is accelerating. Which fiscal action is most likely appropriate to reduce inflatio…
- An economy is operating above potential GDP and inflation is accelerating. Which fiscal action is most likely to be appropriate?