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notes 2 - Intertemporal approach to current account...

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Intertemporal approach to current account determination Viktoria Hnatkovska week 2 1
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Outline We develop a simple microfounded framework for determination of the components in CA = ( S g + S p ) ° I 1. Determination of households°savings behavior, S p . 2. How is investment, I; determined? We will take it as given in this course. 3. Combine the two to understand the interactions between S; I and CA at the aggregate level. 4. How do ±scal de±cits (and S g ) a/ect current account? 2
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Description of a two-period economy De±ne Q 1 endowment of consumption good received in period 1 Q 2 endowment of consumption good received in period 2 C 1 consumption during period 1 C 2 consumption during period 2 B ± 0 asset holdings at the end of period 0 B ± 1 asset holdings at the end of period 1 r 0 interest rate paid on assets held between period 0 and 1 r 1 interest rate paid on assets held between period 1 and 2 Household°s budget constraint during period 1 C 1 + B ± 1 = (1 + r 0 ) B ± 0 + Q 1 Household°s budget constraint during period 2 C 2 + B ± 2 = (1 + r 1 ) B ± 1 + Q 2 It must be the case that B ± 2 = 0 : WHY? 3
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Description of a two-period economy (cont.) Useful de±nitions: GDP and GNP: GDP 1 = and GDP 2 = GNP 1 = and GNP 2 = Savings: S 1 = and S 2 = Net foreign assets (or net international investment position): NIIP 1 = and NIIP 2 = Trade balance in goods and services: TB 1 = and TB 2 = Current account: CA 1 = and CA 2 = 4
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Description of a two-period economy (cont.) Combine budget constraints in periods 1 and 2 to eliminate B ± 1 and B ± 2 and get C 1 + C 2 1 + r 1 = (1 + r 0 ) B ± 0 + Q 1 + Q 2 1 + r 1 (1) Interpretation: The present discounted value of consumption is equal to the present dis- counted value of the endowment plus the initial stock of wealth. Household chooses consumption sequence { C 1 ; C 2 } taking interest rates, r 0 and r 1 ; as well as endowments, Q 1 and Q 2 ; as given.
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