Deck 10: Credit Market Imperfections: Credit Frictions, Financial Crises, and Social Security

Question 1

The phenomenon that some consumers pay a higher interest rate when they borrow than the interest rate they receive when they lend is best described as an example of

A) irrational behaviour.
B) a credit market imperfection.
C) a vast banking conspiracy.
D) the burden of public debt.
E) predatory lending practices.

Answer 1

B

Question 2

An interest rate spread is

A) the difference between long-term and short-term interest rates.
B) the difference between nominal and real interest rates.
C) the difference between lending and borrowing interest rates.
D) the difference between public and commercial interest rates.
E) the difference between the interest rates on different stocks.

Answer 2

C

Question 3

A collateral constraint captures the idea that

A) there is asymmetric information in credit markets.
B) assets may be of no use.
C) consumers need incentives not to abscond on their debts.
D) Ricardian equivalence always holds.
E) the budget constraint is irrelevant.

Answer 3

C

Question 4

In a simple model of credit imperfections, when consumers borrow and lend at different interest rates, the budget line is kinked because

A) the consumer cannot consumer more than disposable income in any period.
B) taxes exceed income.
C) the consumer lends at a higher rate than they borrow.
D) the consumer lends at a lower rate than they borrow.
E) income exceeds taxes.

Question 5

If the proportion of bad borrowers increases,

A) the lending interest rate increases.
B) the lending interest rate decreases.
C) the borrowing interest rate increases.
D) the borrowing interest rate decreases.
E) the borrowing and lending interest rates are equal.

Question 6

Collateralizable wealth is

A) wealth in non-tangible assets.
B) any asset that can be used to obtain a loan.
C) wealth that increases and income increases.
D) wealth based on mortgage lending.
E) any increase in wealth from lending.

Question 7

When there are credit-market imperfections, an increase in government debt may be advantageous because it

A) discourages credit-constrained consumers from borrowing too much.
B) allows credit-constrained consumers to borrow more.
C) eliminates the problems that cause credit-market imperfections.
D) encourages more private saving.

Question 8

If consumers face higher interest rates when their savings is positive than when their savings is negative,

A) Ricardian equivalence holds.
B) there is no asymmetric information.
C) the government may be able to increase welfare by cutting taxes.
D) the size of the government should be reduced.
E) the economy can do without collateral.

Question 9

If there are fewer bad borrowers in the population when there is asymmetric information

A) the interest rate spread declines.
B) the interest rate spread increases.
C) the value of collateral increases.
D) banks make positive profits.
E) good borrowers are worse off.

Question 10

The 1990-1992 recession was unlikely to be associated with financial factors since

A) there was little change in interest rates.
B) consumption did not drop.
C) interest spreads increased right from the start.
D) interest rates for lending and borrowing went up.
E) profits in the banking sector increased.

Question 11

Limited commitment means

A) one cannot credibly promise something.
B) one saves only part of what is optimal.
C) only some households are allowed to save.
D) there is rationing on the credit market.
E) only governments can borrow.

Question 12

Asymmetric information means

A) some market participants have more information than others.
B) some news are more important than others.
C) some market participants interpret news differently.
D) the impact of news on economic outcomes depends on the context.
E) consumers do not understand completely their own preferences.

Question 13

When consumers lend at a lower rate than they borrow, a decrease in current taxes implies

A) current consumption increases by the amount of the tax cut.
B) current consumption remains unchanged.
C) both current and future consumption increase.
D) current savings increases by the amount of the tax cut.
E) current consumption decreases and future consumption increases.

Question 14

The default premium increases when there is a(n)

A) decrease in the fraction of good borrowers.
B) increase in the fraction of good borrowers.
C) increase in the bank profits.
D) decrease in risk.
E) increase in liquidity.

Question 15

In the two-period model, a bank

A) creates money.
B) keeps money safely.
C) multiplies reserves.
D) borrows and lends.
E) is generally unnecessary.

Question 16

If the value of collateral falls for a consumer,

A) current consumption must fall.
B) current consumption must rise.
C) future consumption must fall.
D) current consumption falls only if the collateral constraint binds.
E) current consumption falls only if the collateral constraint does not bind.

Question 17

Asymmetric information in the credit market means that

A) the bank cannot distinguish bad borrowers from good borrowers.
B) the bank cannot prevent consumers from defaulting on their loans.
C) the default rate on loans is excessively high.
D) borrowers can borrow from financial institutions other than banks.
E) consumers can only borrow from banks.

Question 18

A default premium is the interest rate premium

A) under normal market circumstances.
B) when there are no market fluctuations.
C) covering the default risk.
D) for government debt.
E) a borrower receives after defaulting.

Question 19

In the two-period model, the nature of the asymmetric information is that

A) only the bank knows who the bad borrowers are.
B) only borrowers know whether they are bad or not.
C) only borrowers know the value of their collateral.
D) only banks can value the collateral.
E) only consumers know their income when it is received.

Question 20

If consumers use their house as collateral for lending and the value of housing in general falls, then

A) lending is unchanged and future consumption increases.
B) borrowing increases further to maintain current consumption.
C) lending and aggregate consumption decrease.
D) lenders prefer to become borrowers.
E) lending and aggregate consumption increase.

Question 21

In a pay-as-you-go social security system, everyone can be made better off only if

A) the population growth rate exceeds the real interest rate.
B) the real interest rate remains higher than the population growth rate.
C) the number of old households exceeds the number of young households.
D) the interest rate for borrowers is sufficiently below that of lenders.
E) it is preceded by a fully funded system.

Question 22

Pay-as-you-go social security works in situations where

A) Ricardian equivalence holds.
B) the population growth rate exceeds the real interest rate.
C) the population growth rate is less than the real interest rate.
D) the government cannot commit.
E) fully funded social security is illegal.

Question 23

Social security is most likely to present political problems when

A) moving from pay-as-you-go to fully-funded and when population growth is low.
B) moving from pay-as-you-go to fully-funded and when population growth is high.
C) moving from fully-funded to pay-as-you-go and when population growth is low.
D) moving from fully-funded to pay-as-you-go and when population growth is high.
E) moving from pay-as-you-go to fully-funded and when the government funds benefits for the current old generation.

Question 24

The commitment problem that may make a forced savings social security program beneficial is best described by

A) too much saving by households because the government cannot commit to providing zero retirement assistance.
B) borrowers are unable to commit to a high real interest rate.
C) young households cannot commit to participating when they are old.
D) the government cannot commit to providing benefits when old.
E) under saving by households because the government cannot commit to providing zero retirement assistance.

Question 25

Credit market frictions were important during the global financial crisis and the recession of 2008-2009. List two credit market frictions, and discuss how these frictions affect economic activity, and these could have affected economic activity during the 2008-2009 recession.

Question 26

For a consumer bound by the collateral constraint, a reduction in the price of the collateral leads to

A) nothing.
B) an increase in current consumption and a decrease in future consumption.
C) a decrease in current consumption and no change in future consumption.
D) a decrease in current and future consumption.
E) an increase in current and future consumption.

Question 27

If the collateral constraint does not bind, then in response to a decrease in the price, p, of the asset

A) the consumer increases both current and future consumption.
B) the consumer decreases current consumption and future consumption is unchanged.
C) the consumer leaves current consumption unchanged and increases future consumption.
D) the consumer increases current consumption and decreases future consumption.
E) the consumer decreases both current and future consumption.

Question 28

A fully funded social security program

A) solves the Ricardian equivalence problem.
B) works when the population growth rate exceeds the real interest rate.
C) redistributes income between generations.
D) is forced savings, but can work if the government cannot commit to bailing out destitute retirees.
E) is always better than a pay-as-you-go system.

Question 29

Why do consumers benefit from pay-as-you-go social security?

A) It keeps inflation in check as money is redistributed.
B) It is a better way than taxes to finance the government.
C) It forces people to save more than they would otherwise.
D) With sufficiently high population growth, many young contribute to the benefits of the old.
E) With sufficiently low population growth, the young can perpetually contribute more.

Question 30

In a fully-funded social security program

A) the young pay for the benefits of the old.
B) the young are forced to save for their own retirement.
C) the young have to buy bonds for the old.
D) the young are forced to save for the retirement of the old.

Question 31

Consumer choice theory predicts that, with identical consumers, fully-funded social security

A) always makes all generations worse off.
B) makes some generations better off, and cannot make any generation worse off.
C) may make some generations worse off and cannot make any generation better off.
D) may be Pareto improving.
E) can potentially reduce welfare.

Question 32

For a consumer not bound by the collateral constraint, a reduction in the price of the collateral leads to

A) nothing.
B) an increase in current consumption and a decrease in future consumption.
C) a decrease in current consumption and no change in future consumption.
D) a decrease in current and future consumption.
E) no change in current consumption and a decrease in future consumption.

Question 33

Consumer choice theory predicts that, with identical consumers, pay-as-you-go social security

A) always makes all generations worse off.
B) makes some generations better off, and cannot make any generation worse off.
C) may make some generations worse off and cannot make any generation better off.
D) may be Pareto improving.
E) always makes all generations worse off compared to a fully-funded system.

Question 34

In a pay-as-you-go system,

A) the young transfer resources to the old.
B) there is no opportunity for saving.
C) young households pay for their retirement directly.
D) the government pays for retirement.
E) the old receive income from assets purchased when they were young.

Question 35

Moral hazard represents a problem for fully-funded social security because

A) the government is likely to never pay out promised benefits.
B) households invest in assets that are too safe.
C) population growth remains below the real interest rate.
D) households would invest retirement savings in risky assets.
E) population growth exceeds the real interest rate.