Question

Under the Ricardian equivalence proposition, a long sequence of deficits and the associated increase in government debt lead to: a decrease in capital stock. B. an inc rease in consumer spending. OC. achange in investment. D. an increase in private saving equivalent to the decrease in public saving. to recession, the cyclically adjusted deficit is positive, a return to potential output stabilize the debt. If current output is 3% below potential, automatic stabilizers will V the deficit to GDP ratio by

Answer 1

Under the Ricardian equivalence proposition, a long sequence of deficits and the associated increase in government debt lead to D. an increase in private saving equivalent to the decrease in public saving. Total Saving is therefore unaffected and so is investment.

In recession, the government may want to run a deficit large enough that even the cyclically adjusted deficit is positive. In that case, the faxt that the cyclically adjusted deficit is positive provides a useful warning. The warning is that the return of output to its natural level will not be enough to stabalise the debt: the government will have to tale specific measures, from tax increases to cut in spending, to decrease the deficit at some point in the future.

In Australia a rule of thumb is that a 1% decrease in output leads automatically to an increase in deficit of about 0.3 % of the GDP. So, if current output is 3% below potential,the deficit as a ratio of GDP will therefore be about 0.9% larger than it would be if output were at the natural level of output.