Assume a two-period small open economy in which households have logarithmic preferences, U=In(C1)+Bln(C2) where B <1 is the subjective discounting factor. Suppose that households

 

Assume a two-period small open economy in which households have logarithmic preferences, U=In(C1)+Bln(C2) where B 0 (so Q = Q2 = Q). Suppose that every household starts period 1 with a nonzero net asset position (1+ro)B*0# 0. Finally, assume that the country enjoys free capital mobility and that the world interest rate is r*. a) Assume=0.91, Q= 10 and ro-r* = 0.10. Suppose that every household starts period 1 with a negative net asset position equal to (1+ro)B*0=10 (minus 10). With these values, calculate the equilibrium values of consumption (C), the trade balance (TB), and the current account in period 1 (CA). Do not forget to show step by step your algebraic calculations. No credit without explanation. b) Suppose now that (1+ro)B*0= 0 rather than 10. Calculate the effect of this reduction in the initial external debt on the equilibrium values of consumption (C), the trade balance (TB), and the current account in period 1 (CA). Do not forget to show step by step your algebraic calculations. No credit without explanation. c) Provide an intuitive explanation of why the equilibrium values of consumption (C), the trade balance (TB), and the current account in period 1 (CA) change between parts 3.a and 3.b.