Key Concepts and Summary

Key Concepts and Summary

The theory of Ricardian equivalence holds that changes in government borrowing or saving will be offset by changes in private saving. Thus, higher budget deficits will be offset by greater private saving, while larger budget surpluses will be offset by greater private borrowing. If the theory holds true, then changes in government borrowing or saving would have no effect on private investment in physical capital or on the trade balance. However, empirical evidence suggests that the theory holds true only partially.

Glossary

Ricardian equivalence

the theory that rational private households might shift their saving to offset government saving or borrowing

twin deficits

deficits that occur when a country is running both a trade and a budget deficit