2. Consider the Redux model. Fix Mt = M∗ t = M0 for all t. Begin in the ë0í equilibrium.

(a) Consider a permanent increase in home government spending, Gt = G>G0 = 0. at time t. Show that the shock leads to a home depreciation of Sàt = (1 + θ)(1 + r) r(θ2 − 1) + ²[r(1 + θ)+2θ] g, à and an effect on the current account of, àb = (1 − n)[²(1 − θ) + θ2 − 1] ²[r(1 + θ)+2θ + r(θ2 − 1)]g. à What is the likely effect on àb?

(b) Consider a temporary home government spending shock in which Gs = G0 = 0 for s ≥ t + 1, and Gt > 0. Show that the effect on the depreciation and current account are, Sàt = (1 + θ)r ²[r(1 + θ)+2θ + r(θ2 − 1)]gàt, àb = −²(1 − n)2θ(1 + r) r²[r(1 + θ)+2θ + r(θ2 − 1)]gàt.