In the example (“Limited Commitment and Market Interest Rates”), suppose that v < y' and y'/y < a < b.
(a) Suppose that t = t’ = 0. Determine the equilibrium real interest rate, and the equilibrium quantities of current and future consumption for lenders and borrowers.
(b) Determine an efficient tax policy. This will be the tax policy that relaxes the limited commitment constraints for consumers.
(c) Discuss your results in parts (a) and (b).