Problem Set B Eco 5700_6700 Solutions

Problem Set B Eco 5700_6700 Solutions - LATIKA GUPTA Wayne...

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LATIKA GUPTA Wayne State University Department of Economics Fall 2009 Eco 5700/6700 Problem Set B (10 Points) Due Date: Tuesday, October 13, 2009 in class. Questions 1 and 2 are worth 2 points each. Questions 3 and 4 are worth 3 points each. 1. How can financial liberalizations lead to financial crises? With restrictions lifted or new financial products, financial institutions often go on a lending spree and expand their lending at a rapid pace. Unfortunately, the managers of these financial institutions may not have the expertise to manage risk appropriately in these new lines of business, leading to overly risky lending. In addition, regulation and government supervision may not keep up with the new activities, further leading to excessive risk taking. When loans eventually go sour, this causes a deterioration in financial institution balance sheets, a decrease in lending and therefore a decrease in economic activity. 2. How can government fiscal imbalances lead to a financial crisis?
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