In the example with credit market imperfections in general equilibrium, suppose that borrowers can default on their tax liabilities in the same way they default on their liabilities to private sector lenders. That is, in the future period, each borrower owes−s(1+r) to private lenders, and owes t′ to the government, so each borrower faces the borrowing constraint: −s(1+r) + t′ ≤ d.
(a) Given this difference in the borrowing constraint, determine the consumption of lenders, the consumption of borrowers, in the current and future periods, and the market real interest rate in equilibrium.

(b) What are the effects of an increase in the quantity of government debt B on the consumption of lenders and borrowers in the current and future periods, and on the market interest rate?

(c) Explain your results in part (b)

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Credit market imperfections typically characterize a lowquality financial market where the quality of information about borrowers is low andor enforcement rules or institutions are not well developed ... View the full answer