Question

Ricardian equivalence and the government budget constraint: Consider the intertemporal budget constraint in equation (18.5). Assume the interest rate is i 5% (a) Suppose the government cuts taxes today by $100 billion. Describe three possible ways the government can change spending and taxes to satisfy its budget constraint. (b) Suppose consumers obey the permanent-income hypothesis (discussed in Chapter 10). Would their consumption rise, fall, or stay the same for each of the alternatives considered in part (a)? (c) What happens to private saving, total saving, and investment in the three scenarios? Why? (Assume foreign saving does not change.)

Answer 1

Given:- Ricardian equivalence and the government budget contraint: Consider the intentemporal budget constraint in equation (18.5) a) suppose the government cuts taxes today by $ 100 billion. Heru- The legislatwe can: I) quiekly cut spending by $100 billion, ii) cut spending by $105 billion one yecor from now, or ill) caise charge by $ 105 billion one year from now. b) suppose conyumey Obey the peormanent -income by pot hesis (discussed in Chapter 10). Herrein Assurning the Spending doesn't influence lay king pay Ci.e, think about an unadul dezated exchange installmend), the PIH recommends that level headed buycoy won't change them utilization conduct by any stretch of the imagination. This is on the grounds that, for instance, a taze break today without an adjutment in spending will simply bring about less Spending or higher dutie later on, leaving the Por of lifetime extra cash unaltered.

Saving, and (C) what Inugtment happens in the to Private Saving total three scenarios? why? Here's under situation (I), family pay stays unaltered on the grounds that the taxe reduction is counter balanced by a decrease in movie poy. consequently family crit sparing stays unal tesud. the admürüstration Spending continuy as before, so government sparing is unaltered speculation is unaltered given no adjustment in the parts of sparing under Situation in family Salary arise today in view of the tare break. In any case, given PIH customoy, the additional pay is spared in light of the fact that they oualize they won't get $ 105 billion oni 07