If, in an Open Economy with a Real World Interest

question 99

Multiple Choice

If, in an open economy with a real world interest rate of 5%, an output shock (decline) of 21% occurs followed by a recovery the next year:

• A) no consumption smoothing is possible.
• B) the nation can borrow 20% of GDP in the first year and repay 1% of GDP each year in perpetuity resulting in consumption smoothing.
• C) then no borrowing is possible because of the possibility of exceeding the long-run budget constraint.
• D) the economy would have to forswear all international trade and financial flows.

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