Consider a two period economy that has at the beginning of period 1 external wealth of100 In period 1, the country runs a current account deficit of 5 percent of GDP, and GDP in both periods is 120 Assume the interest rate in periods 1 and 2 is 10 percent At the end of period 2, the external wealth must be equal to zero Find the level of the trade balance in period 1, the level of the current account balance in period 1,and the country's external wealth at the beginning of period 2 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 since expenditures cannot be negative, the trade balance cannot exceed GDP Now assume that in period 1, the country runs instead a much larger current account deficit of 10 percent of GDP Find the country's external wealth at the end of period 1 Is the country living beyond its means If so, why OPTIONAL What is the maximum current account deficit (as a share of GDP) that this country can have at time 1 and still live within its means

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Jul 05, 2024

Consider a two-period economy that has at the beginning of period 1 external wealth of100.In period 1, the country runs a current account deficit of

Consider a two-period economy that has at the beginning of period 1 external wealth of100.In period 1, the country runs a current account deficit of 5 percent of GDP, and GDP in both periods is 120. Assume the interest rate in periods 1 and 2 is 10 percent. At the end of period 2, the external wealth must be equal to zero.

Find the level of the trade balance in period 1, the level of the current account balance in period 1,and the country's external wealth at the beginning of period 2.
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 since expenditures cannot be negative, the trade balance cannot exceed GDP].
Now assume that in period 1, the country runs instead a much larger current account deficit of 10 percent of GDP. Find the country's external wealth at the end of period 1. Is the country living beyond its means? If so, why?
OPTIONAL: What is the maximum current account deficit (as a share of GDP) that this country can have at time 1 and still live within its means?