According to Ricardian equivalence, what do households do when the government finances spending with debt?

• A. Consume more now
• B. Save more now
• C. Maintain the same saving and consumption
• D. Increase investment

Answer: (B)

When the government finances spending with debt, Ricardian equivalence says households expect that future taxes will have to rise to pay off that debt. To smooth their consumption over time in light of this anticipated tax burden, they save more today. This saving today offsets the effect of the government’s borrowing, so current consumption doesn’t rise and tends to be constrained by the expected future tax payments.

So saving more now is the natural response to government debt under this idea. If households were to consume more today, it would contradict the expectation of higher future taxes. If they aimed to keep saving and consumption exactly unchanged, the model would imply no reaction at all, which isn’t what Ricardian equivalence predicts. And increasing investment is a different channel tied to firms’ decisions, not the household saving response to debt financing.