SEMESTER 1, 2023
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ECON 7520 SEMESTER 1, 2023
In Lecture 5, we discussed the relation between fiscal deficits and current account imbalances. In our discussion, we assumed that the representative household has the utility function
ln(C1) + ln(C2). (1) Consider now that the representative household is better modeled by a utility function of
ln(C1 + αG1) + ln(C2 + αG2), (2) where α ∈ [0, 1] is a parameter and G1 and G2 are government expenditures in period 1
and 2, respectively. The household takes government expenditures as exogenously given.
Write a report of up to approximately 1,000 words that answers the following questions.
(a) In the baseline model of Lecture 5, the Ricardian equivalence holds. Does the Ricar- dian equivalence continue to hold even if the representative household is modeled by a utility function of the form (2)?
(b) Consider that the government changes the timing of some government expenditures. In particular, assume that the government changes G1 by ∆G1 = ∆G ̸= 0 and G2 by ∆G2 = −(1 + r1)∆G, where r1 denotes the interest rate on assets held between periods 1 and 2. For example, if ∆G < 0 then the government effectively postpones some spending by one period. Discuss how such a change in the government ex- penditure stream affects the consumption and current account balance. How does it affect your answer that (2) rather than (1) models the representative household?
In your report:
• Develop an appropriate model to answer above questions.
• Name a real-world country to which your model might apply. Explain in one sen- tence why your model is appropriate for the country.
• Derive the equilibrium of your model.
• Include appropriate mathematical equations.
• Provide economic intuition for your results.
• Consider including appropriate figure(s).
• Include a word count of your report (excluding equations, figures and references).
Programming Help
ECON 7520 SEMESTER 1, 2023
Marking. The grade of your report will be based on the thoughtfulness and clarity of logics in your explanations. Arguments that go beyond the lecture notes are viewed as an important way to demonstrate thoughtfulness (i.e. it is generally a good idea to leave more space/words to such arguments). Providing a concise and clear intuition for a result also demonstrates thoughtfulness. The following mark-breakdown is anticipated:
• Example of real-world country (5%).
• Economic model (25%).
• Derivation and discussion of equilibrium (30%).
• Ricardian Equivalence (15%).
• Policy analysis of effects of changes in timing of government expenditures (25%).
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