asymmetric information

Answer the following short answer questions in detail and in your own words to demonstrate your understanding of the concepts. Your responses should be from your reading our course ebook (Chapters 11-14, 15 16 & 19, 20-23). You may use additional research sources to explain your answers, and please document your sources.

Chapter 11

  1. What problem associated with asymmetric information was central to Bernard

Madoff’s success in cheating so many investors for so long? 8pts.

  1. In some countries, it is very difficult for shareholders to fire managers when they

do a poor job. What type of financing would you expect to find in those countries?


  1. The financial sector is heavily regulated. Explain how government regulations

help to solve information problems, increasing the effectiveness of financial markets

and institutions. 8pts


  1. Explain why banks’ holdings of cash have increased significantly as a portion of

their balance sheets in recent times. 8pts.


  1. Explain what the phrase “too-big-to-fail” means in reference to financial institutions.

How did the policy responses to the financial crisis of 2007–2009 affect the

too-big-to-fail problem? 8pts


  1. Discuss the regulations that are designed to reduce the moral hazard created by

deposit insurance. 8pts.


  1. In 1900, there were 18 central banks in the world; today, there are about 175.

Why does nearly every country in the world now have a central bank? 8pts.


  1. A small Eastern European economy asks your opinion about whether they should

pursue the path to joining the European Economic and Monetary Union (EMU)

or simply “euroize” (i.e., dollarize by using the euro for all domestic transactions).

What advice would you give? 8pts.


  1. What are the Federal Reserve’s goals, and who established them? How are Fed

officials held accountable for meeting them? Explain why the chair is the most

influential Fed official. 8pts


  1. Federal Reserve buying of mortgage-backed securities is an example of a targeted

asset purchase. Explain how the Fed’s actions are intended to work. 8pts.


  1. Why is inflation higher than money growth in high-inflation countries and lower

than money growth in low-inflation countries? 8pts.


  1. Suppose a natural disaster wipes out a significant portion of the economy’s capital

stock, reducing the potential level of output. What would you expect to happen

to the long-run real interest rate? What impact would this have on the monetary

policy reaction curve and the dynamic aggregate demand curve? 8pts.


  1. The economy has been sluggish, so in an effort to increase output in the short run,

government officials have decided to cut taxes. They are considering two possible

temporary tax cuts of equal size in terms of lost revenue. The first would reduce

the taxes on people with incomes above the median for one year. The second

would cut taxes on people with incomes below the median for one year. Which

change would shift the aggregate demand curve further to the right? Why? 10pts.


  1. Explain in detail how monetary policy influences banks’ lending behavior. Show

how an open market purchase affects the banking system’s balance sheet, and

discuss the impact on the supply of bank loans. (You may wish to refer to Chapter

17 in answering this question.)  10pts.

  1. New developments in information technology have simplified the assessment of

individual borrowers’ creditworthiness. What are the likely consequences for the

structure of the financial system? For monetary policy? 8pts

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