Question: Ricardian equivalence and the government budget constraint: Consider the intertemporal budget constraint in equation (18.5). Assume the interest rate is i = 5%.
(a) Suppose the government cuts taxes today by $100 billion. Describe three possible ways the government can change spending and taxes to satisfy its budget constraint.
(b) Suppose consumers obey the permanent-income hypothesis (discussed in Chapter 10). Would their consumption rise, fall, or stay the same for each of the alternatives considered in part (a)?
(c) What happens to private saving, total saving, and investment in the three scenarios? Why? (Assume foreign saving does not change.)