Good evening professor,
While studying the handout for chapter 7, a doubt arose regarding Hand to Mouth consumers vs Ricardian Consumers.
The scenario given was 7.6.5 "The timing of taxation under borrowing constraint", in which a tax hike would lead to private savings equal to private savings of Ricardian Consumers. However, what if we were on a scenario of a tax decrease in period 1 that will lead to increase taxes (in period 2) equal to the decrease in period 1? Won't HTM consumers have to increase savings in Period 1 to pay these higher taxes in the future?
Another question that arose was: if I am under a borrowing constraint, do we assume also that we cannot lend money? (which for me doesn't make sense, but just making sure).
Best regards,
Tomas Pinto
Hand to Mouth Consumers during tax hike/decrease
Number of replies: 1
In reply to José Tomás Mourão da Cruz Pinto
Re: Hand to Mouth Consumers during tax hike/decrease
by Miguel Lebre Freitas -
The HTM consumer is only constrained on borrowing, not on lendig.
It's consumption function will be C1=(1+p)/(2+p)[omega] in case the interesr rate is high enough for him to prefer to be a saver. IN that case he behaves as a ricardian.
When the interest rate fals to a level that he prefers to become a borrower, he can't, and hence C1=Q1-T1. In that case, a tax increase will imply a fall in C1 on a one to one basis.
A tax cut may imply an increase in consumtion on a 1:1 basis as long as he is still contrained on borrowing. But if the tax cut causes the disposable income today to rise to a level that he prefers to be a lender, then he will act as a ricardian consumer and will expand consumtion only partially.
Basically, it's consumtion function has two brackets (see exercises)
I hope this helps, otherwise let us know
It's consumption function will be C1=(1+p)/(2+p)[omega] in case the interesr rate is high enough for him to prefer to be a saver. IN that case he behaves as a ricardian.
When the interest rate fals to a level that he prefers to become a borrower, he can't, and hence C1=Q1-T1. In that case, a tax increase will imply a fall in C1 on a one to one basis.
A tax cut may imply an increase in consumtion on a 1:1 basis as long as he is still contrained on borrowing. But if the tax cut causes the disposable income today to rise to a level that he prefers to be a lender, then he will act as a ricardian consumer and will expand consumtion only partially.
Basically, it's consumtion function has two brackets (see exercises)
I hope this helps, otherwise let us know