(20 points) Explain how the notion of \"moral hazard\" applied to the 2008-2009

Question

(20 points) Explain how the notion of "moral hazard" applied to the 2008-2009 financial crisis through the passage and administration of the Troubled Asset Relief Program (TARP). In your estimation, was "bailing out" the financial sector merely the best option among bad options or was it just bad policy? Explain the choices facing policymakers at the times and the perceived outcomes of each option. (20 points) Explain, using six declarative statements, how expansionary and contractionary monetary policies can be implemented by changing interest rates, the reserve requirement, and conducting open market operations.

Explanation / Answer

a) The consumer's budget constraint for the current period:

c + s = y - ts, where ts= taxes in all the constraints given

b) The consumer's budget constraint for the future period:

c' = (1+r)s + y' - ts'

c' = (1+r)(1-t) + y' - ts'

c) One lifetime budget constraint:

s = c' - y' + ts'/ (1+r)

d) consumer problem occurs when he has to decide whether to choose present consumption or future consumption. The optimal point occurs where in the graph, the slope of the highest attained indifference curve is equivalent to the slope of the budget constraint.

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