Credit market frictions

Question 1

What explains the spread between the lending rate and the borrowing rate?

Answer 1

1) Financial intermediation
2) Asymmetric information
3) Limited commitment

Question 2

What rate can governments borrow at? What does this do?

Answer 2

The lower rate - lending rate.

It kinks the budget line fro consumers and causes Ricardian equivalence to not follow

Question 3

Effect of a tax cut on a credit constrained consumer

Answer 3

All of the money would be put into current consumption

Question 4

Effect of a tax cut on someone with no credit market imperfections

Answer 4

All of the money would be saved - put into future consumption

Question 5

Asymmetric information

Answer 5

would-be borrowers know more about their own characteristics than lenders do

Question 6

Limited commitment

Answer 6

A contract may not be fully enforceable so collateral can be used.

Question 7

Collateral

Answer 7

When the borrower can no longer pay back the debt, the lender receives the collateral (cash/asset/house)

Question 8

Reduction in creditworthy borrowers on graph

Answer 8

Shifts in the budget constraint from endowment to baseline. Current consumption falls

Question 9

Reduction in creditworthy borrowers

Answer 9

Default premium increases

Question 10

Effect of a fall in value of collateral

Answer 10

HH wealth decreases
Budget constraint shifts inward
Next bit depends on whether the consumer is credit constrained. If a consumer is not borrowing constrained then HH can smooth away some of the effects of a decline in wealth

Question 11

What does binding mean

Answer 11

by this we mean a situation in which the household would like to choose a consumption bundle where it borrows in the first period

Question 12

Permenant income hypothesis

Answer 12

Milton friedman - Increases in future income have a greater effect on current consumption.