Exercise 11.4

Non Equivalence of Temporariness and Lack of Credibility

⬅ Return

Problem

In the body of this chapter, we established the equivalence of temporariness and lack of credibility in the context of a model with a consumption tax (with tradable and nontradable consumption taxed at the same rate). How does this equivalence result change in the economy of exercise 11.3, in which \(\tau_t\) is a tax on tradable consumption only? Specifically, establish whether policy 2 induces the same equilibrium paths of consumption and the real exchange rate as policy 1 when households incorrectly believe that the government will abandon this policy in period \(T=12\) in favor of policy 2. Consider separately the cases of flexible and downwardly rigid nominal wages.

Answer

No solution has been posted yet. If you have a solution, we invite you to share it in the comment box at the bottom of this page.