Intertemporal Macroeconomics

Question 1

Keynesian Consumption function

Answer 1

Static approach - consumption today only depends on current income

Behaviour - the linear form does not account or inform us on household behaviour

Question 2

Intertemporal Model Set Up

Answer 2

Agents are dynamic : they live for more than one period

Agents make decisions : based on constraints faced today and aim to maximise lifetime utility

Intertemporal macroeconomics attempts to capture the dynamic nature of the private and public sectors

Question 3

Assumptions of the Intertemporal Model

Answer 3

Representative agents that live for two periods
Agents have rational expectations and do not make systematic mistakes
There is no uncertainty in the model (no error term) - the future is known in advance
Population does not grow

Question 4

What does the result for optimal consumption tell us?

Answer 4

A temporary increase in income is accompanied by a permanent, but smaller increase in consumption (saving)

A permanent increase in income will result in a permanent increase in consumption of similar size (no saving)

An expected future increase in income, will induce borrowing, but not increase lifetime wealth, only consumption

To increase wealth changes in income must be unanticipated, to induce savings and thus wealth

Question 5

What does the Ricardian Equivalence result tell us?

Answer 5

The sum of private and public spending cannot exceed national wealth - public borrowing must be matched one for one with private saving (taxes)

The pattern of taxation over time has no effect on private wealth

The private sector can see through the veil of government; government promises to pay the principal and interest on public debt are match by taxes levied to service the debt

Question 6

Ways to finance public spending

Answer 6

Tax now or tax later (neither makes any difference) - increases i n G reduce consumption simultaneously