Ricardo-Barro Effect

DEFINITION of 'Ricardo-Barro Effect'

A macroeconomic concept that postulates that when a government runs a budget deficit, households and firms will respond by increasing their level of savings. This behavior allows the aggregate savings of an economy to remain unchanged.

BREAKING DOWN 'Ricardo-Barro Effect'

Under the Ricardo-Barro theory, the government is likely to increase taxes in the future in order to repay the money being borrowed to finance a current budget deficit. As a result, households and firms will increase their current level of savings in order to afford to pay higher taxes in the future.