Economics 304
Economics 304
Winter 2013
Assignment 1 : Due date, Thursday February 7 in Class
1. Consider the following OLG model with money. Assume that the population of the economy grows at rate n such that Nt = nNt−1 for every period and n > 1 and money is also growing in this economy at the rate γ that is Mt = γMt−1 , where γ > 1.
The endowment that each young generation is born with is assumed to be fixed at y. The initial old each receives an equal portion of the money supply Mt .
Suppose that the utility function of a typical agent is given by the familiar log-linear form u(c1,t , c2,t+1 ) = ln c1,t + β ln c2,t+1
(1)
where 0 < β < 1 is the discount factor
(i) Under a monetary economy, what are the first, and second period budget constraints? …show more content…
For example, someone borrows money from a financial institution. The financial institution in turn has to monitor the borrower and make sure that the latter is paying back her loan.
1.5 marks for adverse selection and 1.5 for moral hazard and 1 for costly enforcement. make sure they write a sensible answer, otherwise don’t give them the marks.
(iv) “Financial intermediaries provide an essential maturity and liquidity transformation service”.
In your own words, carefully explain what this statement means. [3 marks]
Financial intermediaries do not only pool savings but they also engage in maturity and liquidity transformation. The proceeds banks receive from depositors (savings) are used to grant loans to
3
other economic agents (households, firms, government). The deposits represent financial claims that the financial intermediary issues (secondary securities) whereas the loans represent the financial claims that the financial intermediary purchases and owns (primary securities). Most of the secondary securities (savings) are highly liquid and can be withdrawn at any time. They have short maturity. On the other hand, primary securities (loans) are very illiquid and have long …show more content…
Financial intermediaries by providing this maturity and liquidity transformation provide an important device as they provide savers the ability to withdraw their funds at any point in time while providing borrowers long with much longer duration. Financial intermediaries can provide this maturity and liquidity transformation only if a portion of savers withdraw their funds in the short-run and only if savers are confident that the will be able to withdraw their funds when needed.
What is important in the answer is that they explain maturity and liquidity. First, they have distinguish between the short-term liabilities (savings) that FI have and the long-term assets (loans). Savings are liquid but not long-term loans (1 mark for saying this). Second, they have to say that savings can be withdrawn at any time
(short-maturity) but loans are usually for long-periods of time (long-maturity). Thus there is a maturity mismatch (1.5 marks). Third, FI provide the essential service of maturity and liquidity transformation only if savers do not withdraw everything at the same time and they have confidence in the FI (0,.5 marks)
Winter 2013
Assignment 1 : Due date, Thursday February 7 in Class
1. Consider the following OLG model with money. Assume that the population of the economy grows at rate n such that Nt = nNt−1 for every period and n > 1 and money is also growing in this economy at the rate γ that is Mt = γMt−1 , where γ > 1.
The endowment that each young generation is born with is assumed to be fixed at y. The initial old each receives an equal portion of the money supply Mt .
Suppose that the utility function of a typical agent is given by the familiar log-linear form u(c1,t , c2,t+1 ) = ln c1,t + β ln c2,t+1
(1)
where 0 < β < 1 is the discount factor
(i) Under a monetary economy, what are the first, and second period budget constraints? …show more content…
For example, someone borrows money from a financial institution. The financial institution in turn has to monitor the borrower and make sure that the latter is paying back her loan.
1.5 marks for adverse selection and 1.5 for moral hazard and 1 for costly enforcement. make sure they write a sensible answer, otherwise don’t give them the marks.
(iv) “Financial intermediaries provide an essential maturity and liquidity transformation service”.
In your own words, carefully explain what this statement means. [3 marks]
Financial intermediaries do not only pool savings but they also engage in maturity and liquidity transformation. The proceeds banks receive from depositors (savings) are used to grant loans to
3
other economic agents (households, firms, government). The deposits represent financial claims that the financial intermediary issues (secondary securities) whereas the loans represent the financial claims that the financial intermediary purchases and owns (primary securities). Most of the secondary securities (savings) are highly liquid and can be withdrawn at any time. They have short maturity. On the other hand, primary securities (loans) are very illiquid and have long …show more content…
Financial intermediaries by providing this maturity and liquidity transformation provide an important device as they provide savers the ability to withdraw their funds at any point in time while providing borrowers long with much longer duration. Financial intermediaries can provide this maturity and liquidity transformation only if a portion of savers withdraw their funds in the short-run and only if savers are confident that the will be able to withdraw their funds when needed.
What is important in the answer is that they explain maturity and liquidity. First, they have distinguish between the short-term liabilities (savings) that FI have and the long-term assets (loans). Savings are liquid but not long-term loans (1 mark for saying this). Second, they have to say that savings can be withdrawn at any time
(short-maturity) but loans are usually for long-periods of time (long-maturity). Thus there is a maturity mismatch (1.5 marks). Third, FI provide the essential service of maturity and liquidity transformation only if savers do not withdraw everything at the same time and they have confidence in the FI (0,.5 marks)