We now move on to the results for Homer. We are going to do the exact...

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We now move on to the results for Homer. We are going to do the exact same exercise that we did for Dagwood. e. Using only the results from 2c and 2e, where y = $200K, derive the desired savings function (for Homer) labeling the point from 2c as point A and the point from 2e as point B. Connect the points and we have the savings function for Homer. Make sure you put in parentheses next to the savings function what we are holding constant. f. Suppose you were Janet Yellen's cousin and was head of the central bank in an economy filled with Dagwoods (savers). Suppose also that your economy was in a recession and you wanted to stimulate consumption today as part of your dual mandate. Suppose the current real rate of interest is zero. Would you raise or lower real interest rates to stimulate consumption? Explain in detail using the substitution and income effects. 11 e) [2.5]In the real-world' situation, are borrowers better or worse off? Explain. f) [2.5] In the 'real-world' situation, are savers better or worse off? Explain. g) [2.5]There is one type of economic agent that does not get influenced by a change in the real interest rate. What characteristics does this type of economic agent have? 13 (20 points total) 4. Below is the foundation of the two-period consumption model discussed in class. You are given the no lending - no borrowing point (NL/NB) for this economic agent. NL/NB a) [2.5]Clearly label both the vertical and the horizontal axis in this model. b) [2.5]Assume the Fed sets the real interest rate at rFED. Draw a budget constraint assuming that this consumer can borrow and save at rFED. Label this BCFED In the 'real world' the rate at which you can borrow and the rate at which you can save are different than the Federal Funds rate set by the FOMC. For instance, the rate at which someone can save is traditionally less than the Federal Funds rate and the rate at which someone can borrow is traditionally higher than the Federal Funds rate. c) [2.5] Why, in the real world, do we traditionally see the rate at which an individual can save is different than the rate at which an individual can borrow? rB Let r represent the rate at which a consumer can borrow, which is greater than rFED and let rs represent the rate at which a consumer can save, which is less than rFED. d) [5]Draw me a budget constraint assuming that r is the rate at which this economic agent can borrow and r is the rate at which this economic agent can save. Label this BCREAL 12 3. (30 points total - 5 points each part) a. What is the net effect of this expansionary monetary policy (i.e., negative real rates of interest) on consumption, all else constant? To answer this question, assume we have an equal amount of "Dagwoods" and "Homers" so we can simply add the change in Dagwood's consumption to the change in Homer's consumption. Please give the actual change in consumption, given this expansionary policy. Change in Dagwood's consumption: Change in Homer's consumption: Net change in consumption: b. Now consider the case where Homer is credit constrained and thus, cannot qualify for cheap loans since his balance sheet is a wreck. As such, the real rate of interest that Homer faces is 10% (r = 0.10), and not the ultra-low negative real rate = -.05 that Dagwood (who has a solid balance sheet) faces. Please re-answer part a) above, assuming that Homer faces a real rate of 0.10 and Dagwood faces a real rate of (-.05). Use the actual numbers, that is, add the change in Dagwood's consumption (you already did this in 3a) to the change in Homer's consumption, given that he faces a real rate of 0.10, all else constant (i.e., after his y rose). Change in Dagwood's consumption: 1:00 Change in Homer's consumption: Net change in consumption: 6 We now move on to the results for Homer. We are going to do the exact same exercise that we did for Dagwood. e. Using only the results from 2c and 2e, where y = $200K, derive the desired savings function (for Homer) labeling the point from 2c as point A and the point from 2e as point B. Connect the points and we have the savings function for Homer. Make sure you put in parentheses next to the savings function what we are holding constant. f. Suppose you were Janet Yellen's cousin and was head of the central bank in an economy filled with Dagwoods (savers). Suppose also that your economy was in a recession and you wanted to stimulate consumption today as part of your dual mandate. Suppose the current real rate of interest is zero. Would you raise or lower real interest rates to stimulate consumption? Explain in detail using the substitution and income effects. 11 e) [2.5]In the real-world' situation, are borrowers better or worse off? Explain. f) [2.5] In the 'real-world' situation, are savers better or worse off? Explain. g) [2.5]There is one type of economic agent that does not get influenced by a change in the real interest rate. What characteristics does this type of economic agent have? 13 (20 points total) 4. Below is the foundation of the two-period consumption model discussed in class. You are given the no lending - no borrowing point (NL/NB) for this economic agent. NL/NB a) [2.5]Clearly label both the vertical and the horizontal axis in this model. b) [2.5]Assume the Fed sets the real interest rate at rFED. Draw a budget constraint assuming that this consumer can borrow and save at rFED. Label this BCFED In the 'real world' the rate at which you can borrow and the rate at which you can save are different than the Federal Funds rate set by the FOMC. For instance, the rate at which someone can save is traditionally less than the Federal Funds rate and the rate at which someone can borrow is traditionally higher than the Federal Funds rate. c) [2.5] Why, in the real world, do we traditionally see the rate at which an individual can save is different than the rate at which an individual can borrow? rB Let r represent the rate at which a consumer can borrow, which is greater than rFED and let rs represent the rate at which a consumer can save, which is less than rFED. d) [5]Draw me a budget constraint assuming that r is the rate at which this economic agent can borrow and r is the rate at which this economic agent can save. Label this BCREAL 12 3. (30 points total - 5 points each part) a. What is the net effect of this expansionary monetary policy (i.e., negative real rates of interest) on consumption, all else constant? To answer this question, assume we have an equal amount of "Dagwoods" and "Homers" so we can simply add the change in Dagwood's consumption to the change in Homer's consumption. Please give the actual change in consumption, given this expansionary policy. Change in Dagwood's consumption: Change in Homer's consumption: Net change in consumption: b. Now consider the case where Homer is credit constrained and thus, cannot qualify for cheap loans since his balance sheet is a wreck. As such, the real rate of interest that Homer faces is 10% (r = 0.10), and not the ultra-low negative real rate = -.05 that Dagwood (who has a solid balance sheet) faces. Please re-answer part a) above, assuming that Homer faces a real rate of 0.10 and Dagwood faces a real rate of (-.05). Use the actual numbers, that is, add the change in Dagwood's consumption (you already did this in 3a) to the change in Homer's consumption, given that he faces a real rate of 0.10, all else constant (i.e., after his y rose). Change in Dagwood's consumption: 1:00 Change in Homer's consumption: Net change in consumption: 6