Intertemporal Trade: Model with Government Spending Answer all parts (a)-(d) of this question. Consider a model of a small open economy with two periods t = 1, 2. The economy can lend and borrow on international financial markets at (gross) interest rate 1 + r. Domestic output at date t is denoted Yt . Domestic output at dates 1 and 2 is the same: Y1 = Y2 = Y . The representative household has preferences given by U(C1, C2) = ln(C1) + ln(C2) where (0, 1) is a discount factor. The government levies taxes on the representative household in order to finance (wasteful) government spending G1 and G2 in periods 1 and 2. (Taxes are equal to government spending in every period.) (a) [8 marks] Write down the intertemporal budget constraint of the representative household and give an economic interpretation of it. (b) Suppose government spending is zero, that is, G1 = G2 = 0. (i) [12 marks] Derive optimal consumption levels C1 and C2. (ii) [10 marks] Derive the autarky interest rate rA. When does the country run a trade surplus at date 1, when a trade deficit? (c) [10 marks] Suppose the government increases future government spending G2 while keeping current government spending G1 at zero. Explain how this affects the trade balance in periods 1 and 2, compared to the case without government spending. Give an intuitive explanation of your answer. (No derivations needed.) (d) [10 marks] Suppose now that the world interest is given by 1 + r = 1 and suppose government spending is constant at G1 = G2 = G > 0. What are optimal consumption levels C1 and C2? What is the trade balance in periods 1 and 2? Explain your answer.