4 Ricardian Equivalence (30 points) Consider a two period model in which consumers receive exogenous income y in the rst period and y' in the second period. Suppose that the government taxes the individuals with a lumpsum tax t in the rst period and t' in the second period. Suppose that legislatures propose three policies, suppose that the aim is to increase the welfare of households. 0 The rst policy is to reduce current period taxes (t l) without changing government spending (Hint: which means future taxes will be increased (t' T)). o The second policy is to decrease rst period government spending (9 l) and decreasing the current period taxes (t J.) by the same amount. 0 Finally the third policy is to decrease the rst period government spending (g J.) as in the second case but instead of decreasing the taxes, use the reduction in government spending to decrease the government debt (I) l) (Hint: which means future taxes will be decreased (13' l)). a Analyze the impact of each policy proposal on the rst and second period consumption, and saving of the consumer. Compare the welfare implications of each policy. Which policy do you think the government should implement? b Can you think about any limitations of the model which can potentially change the qualitative implications of the policies? Explain