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chapter10_solutions new copy.pdf

9 Pages

Course Code
ECON 2450

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CHAPTER 10 Credit Market Imperfections Credit Frictions Financial Crises and Social Security KEY IDEAS IN THIS CHAPTER1The ideas of Chapter 9 are extended to cases where Ricardian equivalence may not hold and government debt can matter2 Two key credit market frictions are asymmetric information and limited commitment There is asymmetric information when participants in a particular market or the two parties to a particular exchange have different information In this chapter we are particularly interested in asymmetric information in credit marketssituations where borrowers know more about their creditworthiness than do lenders Limited commitment refers to situations where the party to a particular contract is not committed to fulfilling the terms of that contract in the future In loan contracts limited commitment means that the borrower always has the option of not repaying the loan in the future Lenders use collateral to offset the negative effects of limited commitment3 Asymmetric information and limited commitment are important for financial crises During a financial crisis there is more uncertainty in credit markets which increases interest rate spreads and reduces lending and consumption As well the value of collateral falls which also reduces lending and consumption4 There are two kinds of social security programspayasyougo and fully funded The rationale for social security is studied as well as the potential economic benefitsNEW IN THE FOURTH EDITION1 This chapter has been broken off from Chapter 9 though most of the ideas were in the third edition 2 New Theory Confronts the Data Asymmetric Information and Interest Rate Spreads 3 Charts and tables have been updated to reflect new data TEACHING GOALSCredit market frictions and social security may not appear to be related issues so it is important to stress that this chapter extends the ideas of Chapter 9 by considering instances where credit markets are not perfect In a world with frictionless credit markets as considered in Chapter 9 there would be no financial crises or social security for example Copyright2013 Pearson Canada Inc 109
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