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This question considers nancial market imperfections. Assume that the agent must pay a higher rate to borrow (at rate Tb) than he receives when he
This question considers nancial market imperfections. Assume that the agent must pay a higher rate to borrow (at rate Tb) than he receives when he lends (at rate r). Let y+tr denote current after- transfer income, and y'+tr' denote future after-transfer income. b) Consider a policy whereby the government reduces transfer today and promises to raise transfer in the future such that the present value of transfers does not change (the government can borrow or lend at the same rate of r). This change causes agents to borrow today and repay tomorrow. Use your graph to illustrate the effects on current and future consumption. Explain whether Ricardian Equivalence holds or not holds? (8 points) 0) Use the classical model to illustrate the effects of this policy on current output, the real interest rate, the equilibrium level of employment, and the real wage rate (assume given a real interest rate level, the relationship between wage rate and labor supply does not react to this policy). Explain careilly why any curves shift. (8 points)
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