Does Ricardian Equivalence hold or fail to this borrower?

Suppose that there is an asymmetric information in the credit market. Borrowing rate r2 is greater t Show more Suppose that there is an asymmetric information in the credit market. Borrowing rate r2 is greater than lending rate r1 r2 > r1 and government faces the lending rate r1. Consumers face lump-sum tax in this period t1 and the next period t2. Suppose that the government offers a tax-cut today by t amount but the consumers are aware that there will be a tax increase by (1 + r1)t in the next period. (a) Consider the credit-constrained consumer who does not save or borrow before the tax-cut. Does Ricardian Equivalence hold or fail to this consumer? Show that this consumer can remain as credit-constrained (does not save or borrow anything) after the tax-cut. (b) Consider another credit-constrained consumer who does not save or borrow before the taxcut. He has different preference from the consumer in (a): he has lower MRScc0 for any consumption bundle (c c0 ). Show that this consumer can switch to be the lender after the tax-cut. (c) Consider a lender before the tax-cut. Does Ricardian Equivalence hold or fail to this lender? Show that this consumer must remain as the lender after the tax-cut. (d) Consider a borrower before the tax-cut. Does Ricardian Equivalence hold or fail to this borrower? Show that this consumer can remain as the borrower after the tax-cut. 2 (e) Consider another borrower who has lower MRScc0 than the borrower in (d). Show that this consumer may not be the borrower any more after the tax-cut. Show less

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