a) If borrowing is allowed, write down the government's budget constraint. (b) Following Part a), suppose that the government decreases t and increases t' in such a way that the government budget constraint holds. Does this have any effect on each consumer's decisions about how much to consume in each period and how much to save? (c) Does Ricardian equivalence hold in this economy? Explain.
Suppose that there is a credit market imperfection due to asymmetric information. In the economy, a fraction b of consumers consists of lenders, who each receive an endowment of y units of the consumption good in the current period and 0 units in the future period. A fraction 1-b of consumers are borrowers who each receive an endowment of 0 units in the current period and y units in the future period. The government sets G = G', and each consumer is asked to pay a lump-sum tax of t in the current period and t' in the future period.
(a) If borrowing is allowed, write down the government's budget constraint.
(b) Following Part a), suppose that the government decreases t and increases t' in such a way that the government budget constraint holds. Does this have any effect on each consumer's decisions about how much to consume in each period and how much to save?
(c) Does Ricardian equivalence hold in this economy? Explain.
(d) Assume now that no borrowing is allowed, write down the government's budget constraint, making sure to taking account of who is able to pay taxes and who cannot pay.
(e) How does the same fiscal policy change in Part b) affect each consumer's consumption choices? Does Ricardian equivalence hold in this case? Explain.
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