2 Current Account Sustainability

Consider a two-period economy that has at the beginning of period 1 a net foreign asset position of -100. In period 1, the country runs a current account deficit of 5 percent of GDP, and GDP in both periods is 150. Assume the interest rate in periods 1 and 2 is 10 percent. [To answer the following questions, ignore net international compensation to employees and net unilateral transfers.]

1. (5pts) Find the trade balance in period 1 (TB1), the current account balance in period 1 (CA1), and the country's net foreign asset position at the beginning of period 2 (B1).

2. (10pts) 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.]

3. (10pts) Now assume that in period 1, the country runs instead a much larger current account deficit of 30 percent of GDP. Find the country's net foreign asset position at the end of period1

B1. Is the country living beyond its means? If so, show why.