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3. Consumption Smoothing [10 points] Consider the case of a home country where under normal conditions the level of GDP is Q=1000 and consumption C=1000

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3. Consumption Smoothing [10 points] Consider the case of a home country where under normal conditions the level of GDP is Q=1000 and consumption C=1000 and I=G=0. Initially, these conditions are expected to last forever. The world interest rate is r*=0.05=5%. Assume it is now time 0, and that external wealth at the end of all previous period was zero. a. At time 0, under this scenario [1]: What is the present value of output? PV[Q) = What is the present value of consumption? PV[C] = b. Now suppose conditions have changed, and the country has learned of a negative output shock at time t=0. This shock is expected to last one year, and will lead to an output drop of 210 units. That is, GDP at time 0 falls to Q) = 790, then returns to 1000. At time 0, under this scenario [1]: What is the present value of output? PV[Q] = What is the present value of consumption? PV[C] = Assume forward-looking agents desire smooth consumption over time. Compute the new planned levels of consumption at t = 0 and 1 under this scenario. [1] Compute the trade balance, NFIA, current account, and wealth at t = 0 and 1 under this scenario. [1] TBo = NFlAn = CAO = We = T31 = NFlA1 = CA1 = W1 =

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