2. (15 points)Suppose there is a small open economy in our dynamic model with one household.Initially,(i.) the household is borrowing; (ii.) the government is spending in both periods; (iii.) the government has a balanced budget in each period. Then the government decreases its spending in period one only and decreases the level of lump-sum taxes so that it satisfies its lifetime budget constraint. There are two types of tax decreases the government is considering:

Policy 1: Decrease taxes in period one only. Policy 2: Decrease taxes in period two only.

DrawONEhousehold consumption diagram to depict the fall in government spending and to compare and contrast the two tax policies described above with regard to their effects on the followingfirst- periodvariables: (i.) household consumption and savings (ii.) government savings; (iii.) the country's trade balance.