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

Question 1

If the proportion of bad borrowers increases

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

Answer 1

B

Question 2

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

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

Answer 2

B

Question 3

In a fully-funded social security program

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

Answer 3

C

Question 4

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

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

Question 5

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

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

Question 6

A collateral constraint captures the idea that

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

Question 7

Limited commitment means

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

Question 8

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

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

Question 9

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

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

Question 10

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)under saving by households because the government cannot commit to providing zero retirement assistance.
D)the government cannot commit to providing benefits when old.
E)young households cannot commit to participating when they are old.

Question 11

If the value of collateral falls for a consumer

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

Question 12

In the example with credit market imperfections in general equilibrium

A)there is no taxation.
B)consumers face a borrowing constraint.
C)consumers face a collateral constraint.
D)there is asymmetric information.
E)Ricardian equivalence holds.

Question 13

The default premium increases when there is a(n)

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

Question 14

Social security is most likely to present political problems when

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

Question 15

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

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

Question 16

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

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

Question 17

In the example with credit market imperfections in general equilibrium

A)lenders consume only in the future period and borrowers consume only in the current period.
B)borrowers face a higher market interest rate than does the government.
C)all consumers are identical.
D)lenders consumer only in the current period and borrowers consumer only in the future period.
E)the government never borrows.

Question 18

In the example with credit market imperfections in general equilibrium

A)An increase in government debt lowers the market interest rate.
B)An increase in government debt increases economic welfare for everyone.
C)An increase in government debt is a Pareto improvement.
D)An increase in government debt increases economic welfare for borrowers and reduces welfare for lenders.
E)An increase in government debt decreases economic welfare for everyone.

Question 19

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)eliminates the problems that cause credit-market imperfections.
C)encourages more private saving.
D)allows credit-constrained consumers to borrow more.

Question 20

In the example with credit market imperfections in general equilibrium, if the borrowing constraint binds

A)a reduction in government debt has no effect on the market interest rate.
B)a reduction in government debt lowers the market interest rate.
C)a reduction in government debt has no effect on the consumption of lenders.
D)a reduction in government debt is a Pareto improvement.
E)a reduction in government debt raises the market interest rate.

Question 21

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

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

Question 22

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

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

Question 23

In the two-period model with asymmetric information, a bank

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

Question 24

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

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

Question 25

A default premium is the interest rate premium

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

Question 26

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

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

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

Question 28

A fully funded social security program

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

Question 29

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

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

Question 30

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

Question 31

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 32

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

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

Question 33

Collateralizable wealth is

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

Question 34

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

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

Question 35

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

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

Question 36

An interest rate spread is

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

Question 37

Asymmetric information in the credit market means that

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

Question 38

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 old receive income from assets purchased when they were young.
E)the government pays for retirement.

Question 39

Asymmetric information means

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