1. Explain the relationships between the global savings glut, sub-prime loans, interest rates, 2. How does “securitization” reduce overall risk?

1. Explain the relationships between the global savings glut, sub-prime loans, interest rates,
2. How does “securitization” reduce overall risk?
3. In 1990 East Germany and West Germany became one country again. Where the two parts
had been at a roughly comparable level of economic development before WWII, this was
no longer the case by 1990. West Germany was far richer and far more productive than East
Germany. The economic consequences of the unification were many; the focus here will be
just on the implications of unification for fiscal and monetary policy.
Faced with the large increase in transfers and spending, the German government decided to
rely on a larger deficit to help rebuild East Germany.
a) The immediate effects of unification were to increase demand, not only because
of more investment opportunities, but also because of the increase in spending
and transfers due to unification. Use the IS-LM model to show what happened
to the German economy.
Seeing these developments, the German Central bank (Bundesbank) worried that growth of the
economy was too strong, that the economy was operating at too high a level of activity, and that
the result would be inflation. The central bank concluded that the growth should be slowed.
b) What type of policy would the Bundesbank use to slow down the economy?
Use the IS-LM model to show what would happen to the economy
c) Say what happened to output, consumption, interest rates and investment.
i) In your opinion, which variable adjusts faster, income or the interest rates?
Your answer to i) has implications for the adjustment process. Specifically, if interest rates adjust
faster, the economy is always on the LM curve. If output adjusts faster, then the economy is
always on the IS curve. (please notice there is only one correct answer).
ii) Equipped with the dynamics adjustment described above, reexamine the effect of a
monetary contraction on output and the interest rate.