Economic crisis models

Question 1

Because the money supply is D+R, the fall of the reserves will result in a fall in…

Answer 1

Because the money supply is D+R, the fall of the reserves will result in a fall in an equal fall in domestic credit

Question 2

What determines whether an attack will occur?

Answer 2

The level of reserves determines whether an attack will occur. If reserves fall to an unsustainable level, then speculators will attack the currency to force a devaluation

Question 3

What is the shadow exchange rate?

Answer 3

The shadow exchange rate is the unofficial, private exchange rate that occurs whilst the official exchange rate is fixed.

Question 4

What were the two features that separated 2nd generation models from first generation models?

Answer 4

• Richer specification of what fundamentals are

- Provide a theory of self fulfilling speculation & multiple equilibria

Question 5

A form of moral hazard arises when loosely regulated financial … of a country have some form of … …

Answer 5

A form of moral hazard arises when the unregulated, or loosely
regulated, financial intermediaries of a country have some form of
government guarantee (either explicit or implicit).

Question 6

In a government guarantee scenario, the financial intermediaries are able to borrow at … interest rates and lend at … rates in … investment projects

Answer 6

In this kind of scenario the Önancial intermediaries are able to borrow
at low (government backed/linked) interest rates and lend at
relatively high rates in risky investment projects

Question 7

How does a bubble result from government backed loans?

Answer 7

Companies borrow and invest - inflate price of assets - able to finance more loans - bubble arises

Question 8

In imperfect capital markets, what happens to firms with poor balance sheets?

Answer 8

They cannot invest and so real investment collapses

Question 9

What is a NINJA loan?

Answer 9

Made to people with

• No income
• No job
• No assets

Question 10

What do investors do as a result of treasury bill coupon rates being low?

Answer 10

Investors “Reach for yield” (Purchase riskier securities with higher interest rates)

Question 11

What is collateral?

Answer 11

Asset pledged by borrower to guarantee repayment of a loan

Question 12

What is a subprime mortgage?

Answer 12

Mortgage given to borrowers that fail to meet the traditional standard of “prime” borrowers

Question 13

What is leverage?

Answer 13

Use of borrowed funds to purchase assets

Question 14

Leverage is a major source of bank…

Answer 14

Profitability

Question 15

What is the “double edged sword” of leverage?

Answer 15

It magnifies returns, but also magnifies losses