Q. “Ricardian Equivalence Proposition (REP)” is associated with which of the following?

[A] Foreign Trade

[B] Money Supply

[C] Government spending

[D] Industrial expansion

Answer: C

Ricardian equivalence is an economic theory that says that financing government spending out of current taxes or future taxes (and current deficits) will have equivalent effects on the overall economy.  

  • This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.  
  • The theory argues that people will save based on their expectation of increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.  
  • This also implies that Keynesian fiscal policy will generally be ineffective at boosting economic output and growth.  
  • This theory was developed by David Ricardo in the early 19th century and later was elaborated upon by Harvard professor Robert Barro.  
  • For this reason, Ricardian equivalence is also known as the Barro-Ricardo equivalence proposition. 

Source: Economic Survey 2021 and Investopedia