Consider a household that maximizes utility from consumption over two periods

maxu(C1) +u(C2)

C1,C2

Without any taxation, the household would be subject to the usual intertemporal budget constraint

C1+C2/(1+r)=W

Now, suppose that there is a government that needs to spendGin period 1.This spending must be paid for by taxing the household. The government can either collect a lump sum tax from the household in period 1,or borrow the necessary amount through the international financial market at interest rateRGand repay the loan (including interest) by collecting a lump sum tax from the household in period 2 .

(1) AssumeRG< R. Is it better for the household if the government taxes in period 1,or period 2? Show it mathematically.

(2) Does the Ricardian equivalence hold? Explain why or why not.