Question:

ECON30029 Word Count (Excluding equations): In period 1, Q1 = 9 ON = 12 In period 2, QI = 15.75 ON = 12 . ON = ON Bo =0 r = 5% = 0.05 =r* (before sudden stop) Household's preferences InCT + InCY + Incl + Incy Relative price ratio of nontradables in terms of tradables in period 1 and 2 P2 OUR ATTEMPTED RESONSE (word count begins) (a) Flow budget constraints for Period 1: PICT + PNCY + PT B, = PI QI + PN ON Period 2: PIC[ + PNCN = PI Q! + PNON + (1 + r) PIB] Substituting pi and p2 into the budget constraints, we can write them as Period 1: CI + p1CN + B1 = Q1 + p1Q Period 2: Cf + p. CY = Q: + p=QY + (1 + r)B, (b) The intertemporal budget constraint ("IBC") Eliminating B1\fECON30029 Apply market clearing conditions on IBC: CI + PICN + PON 1+7 = CI + p. ( QN ) + +P=(Q!) 1+r CI + p,(QN) + +21932= 07 + p ON + +P2Q 1+r 1+r IBC now: CI + = Q1 + I+r Using the Euler equation for the tradable good in IBC CI + 1+r = CA + (1+nic] 1+r = 2CF = Q1+ 2 Then, we have solution for dd = =(1+r)(of+ CN = 2P1 - (QI + CN = = (1+r)(Q1+- Substitute all the knowns variables into above expressions: CI = 15.75 9 + 1 + 0.05 = 12 CY = = (1 +0.05) (9 + 15.75 = 12.6 1 + 0. 05. C = Q1 = 12ECON30029 C2 = Q2 = 12 12 = 15.75 For p1: 1+0.05 P1 = 1 For p2: 12 = = (1 + 0.05) (9+- 15.75 1+0.05 P2 = 1. 05 (f) Net foreign asset position of the economy at the end of period 1 From Period 1 budget constraint: CI + p. CN + B1 = Q[ + p.ON Substituting equilibrium values of {CI . CI, CN, CY. p1. p2} 12 + (1)(12) + B1 =9 + (1)(12) B1 =-3 (g) Equilibrium level of the current account ("CAr") balance in periods 1 and 2 CA1 = BI - Bo = -3 CA1 = B1-B1 = 3 By transversality condition, By = 0 (h) Given price indexes for: Domestic: P. = (PNP ); Foreign: Pf = (P/ P! ) From (e), at equilibrium, domestic prices of nontradables in terms of tradables are: Period 1: p, = = = 1 Period 2: p, = - 2 = 1.05 So we have, PI = PN (1.05)P. = PN Given Pr = - PN. T= 1Period 1: p; = - =1 Period 2: p; = = =1 So we have, pl* = PN. PI* = PN Given the Purchasing Power Party ("PPP") holds for tradable goods, the Law Of One Price ("LOOP") must also holds: e = - = 1 The real exchange rate 6. =- In period 1: 6 = 58 - P 1 = = - = 1 PT In period 2: 02 = = P 2 = (1.05)P 1.024695 (1) = 0.9759 Unsure starting from here (i) From (f), the new net foreign asset position of the economy at the end of period 1 CT + piCN + B1 = Q1 + p1QN B1 = Q1 + PION - CI - p. CN B1 =9 - CI New equilibrium levels of the current account balance in periods 1 and 2 CA1 = BI - Bo = 9 - CI CA? = BI - BI = CI - 9 By transversality condition, By = 0 CI = = (QI + ) CI = 4.5 + 2.875 1+r Substituting into BI B1 = 9 - (4.5 + 2.875)ECON30029 B1 = 4.5 - 7.875 1+r Substituting into CAt CA1 = BI - Bo = CI = 4.5 CA? = BI- BI = -CI = -4.5 Given price indexes for: Domestic (Argentina): P, = (PNP]) Foreign (U.S.): Pf = (PN*P) From (e): CN = = (Q] + - 2p1 15.75. P1= 24 1+r CN = 2p2 (1+ r)(Q]+ p2 = = (9(1 + r) + 15.75) PN 15.75 Period 1: p1 = PI = + 1+r Period 2: P2 = ! 1 -= 24 (9(1 + r) + 15.75) ()Question. A sudden stop. Consider a two-period, open economy. In period 1, households receive an endowment of 9 units of tradeable goods and 12 units of nontradable goods. In period 2, households receive 15.75 units of tradables and 12 units of nontradables. Households start period 1 with no assets or liabilities. The country enjoys free access to world financial markets, where the prevailing interest rate is 5 percent. Suppose the household's preferences are defined over consumption of tradable and nontradable goods in period 1 and 2 as follows: In Of + In CN + In C7 + In CN where Of and ON denote tradable and nontradable consumption in each period t. Let p, and pz denote the price of nontradables in terms of tradables in period 1 and 2. a. Write the household's flow budget constraints in each period 1 and 2. b. Derive the intertemporal budget constraint. c. Derive the optimality conditions for utility maximization. d. Write down the market clearing conditions in the nontradables market in periods 1 and 2. e. Solve for the equilibrium values of {Cf, ON, CY, Cf, pu, p2)- f. Calculate the net foreign asset position of the economy at the end of period 1. g. Calculate the equilibrium level of the current account balance in periods 1 and 2. h. Assume that the domestic consumer price index in period 1 and 2 denoted , is given by P = (PNPT)" where IN and 17 denote the price of nontradables and tradables. Suppose the foreign price index is given P = (PN Pi.)". Foreign prices are expressed in units of foreign currency. Assume that PPP holds for tradable goods. Assume that foreign price of nontradables in terms of tradables is equal to unity in each period. Compute the real exchange rate in each period. i. Now consider a scenario like the one that took place during the Argentine sudden stop of 2001 by assuming that because of fears that the country will not repay its debts in period 2, foreign lenders refuse to extend loans to the domestic economy in period 1. Compute the equilibrium interest rate. Compute the relative price of non-tradables and the real exchange rate in periods 1 and 2. Prvoide intuition for your results. j. Compute real GDP in period 1 under the sudden stop and no-sudden stop scenarios. Consider two alternative measures of real GDP. GDP measured in terms of tradable goods and GDP measured in terms of the basket of goods whose price is the consumer price index. If you were an advisor to the Argentine government, which measure would better reflect the economic consequences of a sudden stop