1 Ricardian equivalence and consumption smoothing In this problem, we analyze the problem a government that needs to finance government expenditures using two alternatives - either taxing the household in period 1, or borrowing the money (from abroad) and repaying it in period 2 from taxes raised in period 2. We will show that in the neoclassical consumption model, as long as the households can borrow and save at the same interest rates as the government and the taxes are not distortionary, then there is no difference between the two alternatives - timing of taxes does not matter, a result known as Ricardian equivalence. Consider the maximization problem of the household discussed in class, max u (c1) + Bu (c2) C1, C2 subject to the budget constraints, c1 + s1 = y1 C2 = y2 + (1 + R) $1 Assume here that the financial wealth is zero, f1 = 0. Question 1.1 Derive the intetemporal budget constraint