CFA Level I · CFA Level I Exam · Fiscal Policy
Ricardian equivalence is best described as the argument that, when a government finances a tax cut by issuing debt, households will:
Ricardian equivalence holds that households see debt-financed tax cuts as deferred taxes, so they save the extra income to meet future tax liabilities. Higher private saving offsets the government's deficit, leaving aggregate demand largely unchanged.
- ASpend the full tax cut, raising aggregate demand
- BIncrease saving to pay for future higher taxes, offsetting the stimulusCorrect
- CReduce saving because bond yields rise
Explanation
Ricardian equivalence says rational households anticipate that debt must be repaid with future taxes. They save the tax cut, so private saving rises by the amount of government dissaving and demand is unchanged. The first option is the usual Keynesian view.
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
- A country has a high debt-to-GDP ratio and investors begin to doubt its ability to repay. Which outcome is most likely to limit the governme…
- Which of the following is best described as an automatic stabilizer?
- 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…