Keynes vs. Fisher Keynes: Current consumption depends only on current income.
{"Image DocumentName": "Keynes vs. FisherKeynes: Current consumption depends only on current income.", "Image ImageDescription": "Fisher: Current consumption depends only on the present value of lifetime income. The timing of income is irrelevant because the consumer can borrow or lend between periods. If you covered Ricardian Equivalence in Chapter 15, you might wish to revisit it briefly at or around this point in the presentation. Draw the intertemporal budget constraint. Pick a point on it to represent (Y1\u2013T1, Y2\u2013T2). Now suppose the government gives each consumer a one-unit tax cut. Disposable income in period 1 rises by 1. Assume the government is not changing G1 or G2, and, just to keep things simple, assume that the government\u2019s budget was balanced prior to the tax cut. Then, cutting taxes by one unit in period 1 requires that the government borrow one unit in period 1, which it must repay with interest in period 2. In order to retire this debt in period 2, the government must raise period-2 taxes by (1+r). Thus, disposable income rises by 1 in period 1 and falls by (1+r) in period 2. Notice that the present value of the fall in period-2 income is exactly equal to the rise in period 1 income. Thus, consumer is not any better off. What\u2019s happened here is that the government has altered the timing of taxes (shifting some of the burden from the present to the future), but has not altered the present value of lifetime taxes. Therefore, the budget constraint does not shift out. Rather, the income point simply moves along the line toward the southeast (one unit to the right, and 1+r units downward). The combination (C1, C2) that was optimal before will still be feasible and optimal. CHAPTER 16 Consumption.", "Image XResolution": "37", "Image YResolution": "37", "Image ResolutionUnit": "Pixels/Centimeter", "Image Software": "SlidePlayer", "Image YCbCrPositioning": "Centered"}