Consider a two-period economy that at the beginning of period 1 has a net foreign asset position of −100. In period 1, the country runs a current account

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ECON 7520 SEMESTER 1, 2023

deficit of 5 percent of GDP, and GDP in both periods is 120. Assume the interest rate in periods 1 and 2 is 10 percent.

(a) Find the trade balance in period 1 (T B1), the current account balance in period 1 (CA1), and the country’s net foreign asset position at the beginning of period 2 (B1).

(b) Is the country living beyond its means? To answer this question find the country’s current account balance in period 2 and the associated trade balance in period 2. Is this value for the trade balance feasible? [Hint: Keep in mind that the trade balance cannot exceed GDP.]

(c) Now assume that in period 1, the country instead runs a much larger current account deficit of 10 percent of GDP. Find the country’s net foreign asset position at the end of period 1, B1. Is the country living beyond its means? If so, show why.

# Now assume that in period 1, the country instead runs a much larger current account deficit of 10 percent of GDP. Find the country’s net foreign asset position at the end of period 1, B1. Is the country living beyond its means? If so, show why.

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