3. Suppose in our two-period model of the economy that the government, instead of borrowing in the current period, runs a government loan program. That is, loans are made to consumers at the market real interest rate r, with the aggregate quantity of loans made in the current period denoted by L. Government loans are financed by lump-sum taxes on consumers in the current period, and we assume that government spending is zero in the current and future periods. In the future period, when consumers repay the government loans, the government rebates this amount as lump-sum transfers (negative taxes) to consumers. (a) Write down the government's current-period budget constraint and its future-period budget constraint. (b) Determine the present-value budget constraint of the government. (c) Write down the lifetime budget constraint of a consumer. (d) Show that the size of the government loan program (i.e., the quantity L) has no effect on current consumption, future consumption, and the equilibrium real interest rate. Explain this result. How is it related to the Ricardian Equivalence Theorem? Problem 4. Consider a two-period economy where the credit market is imperfect. The real interest rate of lending, r1, is smaller than the rate of borrowing, r2. If the current-period output changes, use diagrams to illustrate how does it affect the current-period consump- tion? Show that the credit market imperfection can resolve the issue of excess volatility in consumption. 1