intertemporal budget constraints and ricardian equivalence

Question 1

intertemporal

Answer 1

the relationship between yesterday (the past), today(the present) and tomorrow(the future)

Question 2

assumptions made week 1

Answer 2

Assets and liabilities are traded in perfect financial markets.

two periods only present and future e.g this year/next year

perfect foresight- people anticipate the future correctly

rational expectations- on average agents forecast correctly

household consumes all income across two periods

some disposable income today (y1) and some tomorrow (y2)

one real interest rate (r)- either borrow from future self (pay interest) or save income (receive interest)

Question 3

why do financial markets exist

Answer 3

to link present with the future

Question 4

types of intemporal things

Answer 4

consumption and investment decisions are intertemporal (trades off today and tomorrow)

borrowing and lending intertemporal trade

Question 5

What is the inter temporal budget constraint

Answer 5

how much a household can spend today and in the future based on their total resources (wealth). cant spend more than what you have

Question 6

week 1 assumptions about inter temporal budget constraint

Answer 6

households can borrow or save as much as it likes out of income subject to the interest rate

Question 7

real interest rate

Answer 7

difference between nominal interest rate and inflation

Question 8

what does Real interest rate imply

Answer 8

implies the price of tmrw’s consumption in terms of today’s consumption (intertemporal price)

Question 9

Household intertemporal budget constraint equation

Answer 9

C1 + C2/1+r = (Y1-T1) + (Y2-T2)/1+r

present discounted value of consumption = present discounted value of income = total wealth (in terms of today’s income

Question 10

discounting

Answer 10

valuing future goods in terms of goods today

Question 11

discounting equation

Answer 11

Present Value= Future Value /(1+real interest rate (r))^number of years

Question 12

saver

Answer 12

consumption tomorrow is equal to tomorrow’s income plus what was saved from today adjusted for the interest payment on what is saved

saver c1 is less than y1

Question 13

borrower

Answer 13

y1-c1 is negative, as consumption today is higher than income today

and the 1+r would be the interest payment on borrowing

Question 14

how does the slope of the IBC shift

Answer 14

depends on r

inheriting indebtness today shifts the IBC inwards

inheriting wealth today shifts the IBC outwards

Question 15

government’s intertemporal budget constraint equation

Answer 15

G1 + G2/1+rG = T1 + T2/1+rG

Question 16

ricardain equivalence

Answer 16

hypothesis, government has to obey its IBC

that the government raising money by taxes or borrowing does not matter as people understand they will have to pay for it later

while current disposable income will increase agents will not increase consumption as they believe taxes will be raised in the future

government borrowing does not change peoples spending because they know its delayed taxes

Question 17

evidence of ricardian equivalence

Answer 17

studies say households save half of tax cuts, ricardian equivalence said to be 50% true

Question 18

limitations of ricardian equivalence

Answer 18

partially verified

• perfect foresight is a demanding assumption, much uncertainty and taxpayers do not realise the extent of their obligation

-governments live forever, future tax may no concern some taxpayers

-assumes consumers can borrow as much as they wish, they can’t

-assumes all people identical, poor pay less tax than rich

-most countries rg<r state can borrow cheaper

• based on income being an exogenous endowment but taxes affect work decisions, saving and investment which could affect future income

Question 19

public and private IBC

Answer 19

C1 + C2/1+r = Y1-G1 + Y2-G2/1+r