assignment 1 points nick

# assignment 1 points nick - Sub prime crisis caused Aus...

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Sub prime crisis caused Aus major banks losing \$ in the US market, People here observe this and lose confidence about banks (whether or not they will be repaid if they lend \$ to banks), so they choose to hold more cash, c increase => 1/ [c+thita(1-c)] decrease Banks observe what people are doing and will increase i to try to encourage deposits, especially when they are already losing money in the sub prime market, and are in need of funding from other sources (“liquidity needs” from the quote). If banks can’t meet their liquidity needs they go bankrupt. Increase in i => decrease I => decrease Y =>decrease \$Y (SR P fixed) So in this equation 1/[c+thita(1-c)] H=\$Y L(i) the 3 terms other than H falls, if CB fix H I have a question here, is 1/[c+thita(1-c)] H=M? (that’s the M in this equation M/P=Y L(i) ) well if they aren’t equal, I am TOTALLY lost If they are equal…. . LM shift to the left (M decrease) => SR ISLM equilibrium of lower Y and higher i. According to Y=Y(M/P,G,T) decrease in M shift AD left => lower Y, lower P. Over time AS shift to the right to intersect AD at Y=Yn (returned to the original Y), but new P=Pe=PT is lower. (we have an inflation target so we don’t want PT to fall, that could be one of the reason CB intervene) ------------------------------------------------------------------------------------------------------- When CB injects liquidity, H increases proportionate to the amount of decrease in 1/ [c+thita(1-c)]. So M is unchanged (1/[c+thita(1-c)] H=M). so everything is unchanged, (or shift everything back right after they change in the way described above) The only thing that is different is the components that make up M But over time, c goes back to where it was (I have no theory to support this…. .), maybe because people see nothing is happening to the economy, so they gained back

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assignment 1 points nick - Sub prime crisis caused Aus...

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