In the Smets-Wouters DSGE model, ________ when there is an increase in government spending because ________.
A) consumption falls; more government spending today means higher taxes later
B) consumption rises; more workers are attracted to higher nominal wages
C) inflation falls; prices are sticky
D) consumption falls; the natural rate of unemployment falls
E) None of these answers is correct.

Question

Quizplus · Accepted Answer

According to the Smets-Wouters DSGE model, consumption falls when there is an increase in government spending because more government spending today means that there will be higher taxes later. This is consistent with the Ricardian equivalence hypothesis, which suggests that individuals anticipate that current government spending will have to be paid for by future taxes and adjust their consumption accordingly.

In the Smets-Wouters DSGE Model, ________ When There Is an Increase