Question

Can you explain the Ricardian Equivalence theorem. How it may fail to hold? And keeping the assumptions made in mind, and discuss the relevance of the theory to the real world effect of fiscal consolidation. A detailed answer please

Answer 1

Recardian equivalence is that type of economic theory which has some relevance arguments and some genuine criticism.

This theory is based on the increasing debt financed spendings by the government.

Sometimes investment will fail when there is no change in the demand in the economy for example suppose there is a new investment of rupees one crore but there is no demand in the economy means there is no new demand in the economy then the new investment of rupees one crore is very difficult to cover up.

According to this theory any extra income will goes in Savings and that's the only reason there is no increase in consumption in the economy.

This theory was developed by the famous economist David Ricardo and afterwards it was explained and elaborated by professor Robert barro.

This theory is in the favour of increasing the government expenditure to uplift the economy by investing new amount in the business so it will create new earning for the public but when there is no demand raise in the economy then the new investment will become a difficult situation because there is no return of investment in this case when demand is unchanged.

# some economist suggested that this theory is based upon unrealistic is assumptions.

Some real world group of Ricardian equivalence that many economist are not in a favour to adopt this theory because in the study it was a big failure in 2008 financial crisis when European Union Nations that were strong coordination with government debt burdens and net financial assets.

It is found that the countries which are having high level of government jobs are also high level of household savings so this is a complete failure of this theory and it was proved in the financial crisis of 2008.