Question

In response to the coronavirus the federal government is borrowing HUGE amounts of money. By the time you read this they will borrow an additional 1 trillion dollars this year.

According to the Ricardian Equivalence, how will this affect household's choice of consumption?

please give a 100-words answer

Answer 1

According to Ricardian Equivalence, the government's attempt to stimulate the economy by increased debt-financing would eventually fail as the consumer demand would remain unchanged. According to the theory, any increased income that the consumer earns due to stimulated economy would be saved by the consumer in anticipation that the government might increase taxes in order to pay off its debt. Arational consumer would see the stimulated income as a bonus rather than a long term increase in income, and hence, would not increase their spending as expected by the government. Hence, the government would fail to stimulate consumer spending which would bring the economy back to a standstill.

In a crisis like coronavirus, the economy is not functioning as the world is under quanrantine or lockdown. In such situations, heavy borrowing can incur more damage to the economy as there is no guarantee how long it will take for the economy to get fully functioning again and the government's debts could continue rising with the economy still being locked down for an unforeseeable period of time.