ECON-UA 316 Final: ECON 316 Final Exam
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316-632 international monetary economics final exam: the permanent-income hypothesis and the current account (60 marks). Con- sider a dynamic, stochastic model of a small open endowment economy that faces a constant real interest rate r > 0 and where an in nitely-lived representative consumer has preferences ordered by. C2 t , a0 > 0 u(ct) ct . Bt+1 bt = rbt + yt ct where {yt} follows an exogenous stochastic process, to be discussed below, and bt denotes net foreign assets. Notice that there is no government expenditure and no investment (no capital accumulation). (a) (7 marks). Iterate the current account identity forward to obtain an intertemporal budget constraint. (b) (7 marks). Show optimizing behavior by the representative consumer requires that the following euler equation be satis ed. If so, what kind of stochastic process must consumption follow? (c) (10 marks). Use the euler equation and the intertemporal budget constraint to solve for the optimal level of consumption.
