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202_ps4_w10 - derived in(b i t hits the lower bound of zero...

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Econ 202, Winter 2010 Problem set 4. Due: Thursday March 4. 1. The basic short run model of the text book takes the form ~ Y t = ° ° b ( R t ° ° r ) ° t = ° t ° 1 + ° v ~ Y t plus a policy rule that speci°es the behavior of R t . Suppose, however, that the central bank±s policy rate R s t is related to the interest rate that appears in the IS relationship R t according to R t = R s t + ° p , (1) where ° p is a mean zero shock to the risk premium. Policy is described by R s t = ° r + ° m ( ° t ° ° ) ° ° p . (2) The nominal policy interest rate is related to the real interest rate by i t = R t + ° t (3) (a) Derive the aggregate demand curve linking ~ Y t and ° t . How is it a/ected by a positive realization of ° p ? (i.e., is it shifted to the left or right?) (b) Use (1) - (3) to write the rule that links i t to in²ation and ° p . (c) Suppose that ° p takes on a value so big that with the policy rule you
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Unformatted text preview: derived in (b), i t hits the lower bound of zero. How does this a/ect your answer to part (c)? What are the dangers posed by the zero lower bound? 2. What is meant by adverse selection? 3. De&ne moral hazard. Given an example of how moral hazard can give rise to credit rationing. 4. How do banks create liquidity? Why does this make them at risk of a bank run? 5. Using data from FRED, plot the e/ective federal funds rate (FEDFUNDS), the 3-year constant maturity rate on government securities (GS3), and the rate on Baa corporate bonds (BAA). Use monthly data, from Jan. 1990 to the most recent observation. Has the relationship among these three interest rates changed since 2007? 1...
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