The Barro-Ricardo equivalence proposition
A)states that debt-financing merely postpones taxation and therefore in many instances is equivalent to current taxation
B)relies on the absence of liquidity constraints and the presence of an operational bequest motive
C)implies that a cut in current taxes that carries with it an implied increase in future taxes will lead to an increase in private saving
D)was not supported by events of the 1980s as taxes were cut, budget deficits increased, and private saving declined
E)all of the above

Question

Quizplus · Accepted Answer

The Barro-Ricardo equivalence proposition, also known as Ricardian equivalence, suggests that the method of government financing (taxation vs. debt) does not affect the total level of demand in the economy. This is because rational agents foresee that debt financing will lead to future taxation to pay off the debt, and thus they increase their savings to offset the future tax burden. This proposition relies on assumptions such as no liquidity constraints and the presence of a bequest motive. The events of the 1980s, where tax cuts led to increased deficits and a decline in private saving, are often cited as evidence against the practical applicability of Ricardian equivalence, highlighting the importance of real-world constraints and behaviors that may deviate from the model's assumptions.

The Barro-Ricardo Equivalence Proposition