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Unformatted text preview: Monetary Economics I: Financial Markets and Institutions ECON 3430 B Solutions to Problem Set II December 8, 2009 Professor Ahmet Akyol Questions 1. Consider an overlapping generations economy with 400 lenders and 200 borrowers born in every period. Everyone lives for two periods. Each lender is endowed with 10 goods when young and nothing when old. Each borrower is endowed with nothing when young and 40 goods when old. Each lender wants to save 5 goods, regardless of the rate of return on their savings. Each borrower wants to borrow 10 /r goods, when r is the gross real return on private IOUs. The lending (IOU) market is competitive. (a) In a non-monetary equilibrium, what is the equilibrium interest rate? In a non-monetary equilibrium, money has no value, and personal IOUs are the only asset. In equilibrium, the demand for these IOUs must be equal to the demand for these IOUs. Since, there are 400 lenders and each of them saves 5 goods to purchase IOUs, total demand for IOUs is: 400 5 goods = 2000 goods. Similarly, there are 200 borrowers, and each of them borrows 10 /r goods when they sell IOUs. Thus, total supply of IOUs is 200 10 /r = 2000 /r goods. Then, 2000 = 2000 /r (1) which implies that the groos equilibrium interest rate is one, or...
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