1. Consider the intertemporal model with two time periods. Home is a small open economy that

can borrow and lend in the first period at a fixed world real interest rate of r? = 4%. In the

first period output is Q0 = 800. Because of a recession, output in the second period output is

expected to fall to Q1 = 500. The country wants to smooth consumption as much as possible.

The country begins with no external assets or liabilities. Finally, assume that the intertemporal

utility function at home is

u(c0) + u(c1)

where =

1

1+r? , u is concave (i.e. consumers are risk averse and want to smooth consumption).

(a) Solve for consumption, the current account, and financial account in the first period (t = 0).