Question: In a closed economy, private savings plus government savings must equal investment.
I= Sp + 3g.
a. Draw a savings-investment diagram to show the effect of an increased budget deficit
b. Assume that the increased government deficit is the result of increased government investment, and that the government investment increases the returns on private investment, so that at each interest rate there is increased private investment. Show the effect of the deficit on investment and interest rates now.
c. Assume that Ricardian equivalence holds. What happens to national savings when the government increases the deficit? What happens to private savings?
d. Ricardian equivalence focuses on the impact of future tax liabilities associated with increased deficits on private savings. What implications does the logic of Ricardian equivalence have for the consequences of additional public investment? In particular, what will be the impact on private savings of an increased deficit used to finance public investment which has a very high return, which will be realized only in the lives of the next generation?