Or the following model: In this model, the redundant equation is hs = hh. We make the assumption that the central bank fixes the interest rate rt = 0.03 and the government spends gt = 50 at all periods. Assumptions = 0.2, 1 = 0.6, 2 = 0.4, 0 = 0.635, 1 = 5 and 2 = 0.01. 2a) In a steady state, what is the level of GDP yt and consumption ct? What is the debt-to-GDP? 2b) In a steady state, what is the total amount of interest paid by the government? What is the amount interest paid to the household sector by the government? 2c) Define the Governments effective interest rate as the ratio of interest charges paid to households by the government on the governments TOTAL debt. Calculate the effective interest rate of the government. Is it higher or lower than the interest rate determined by the central bank? 2d) Find now the level of GDP, consumption and debt-to-GDP ratio by assuming that 1 = 0.8 and 2 = 0.2. Is your answer different from that found in 2a)? For the rest of the question, assume that 1 = 10 rt 1. 2 2e) Let us assume initially that 10 = 0.75 and = 5 and that 2 = 0.4. What is the value of 1 in the state stationary?

2f) Graphically illustrate what happens to consumption when the central bank increases interest rate from 3% to 3.5%. use start=5. Represent your response by terms of deviation in % from the initial steady state. 2g) Let us now assume that 10 = 0.95 and = 5 and that 2 = 0.2. What is the value of 1 in the state stationary? 2h) Graphically illustrate what happens to consumption when the central bank increases interest rate from 3% to 3.5%. use start=5. Represent your response by shock less control over the initial stationary state. 2i) Plot, in the same chart, the consumer response to the interest rate shock as you obtained in 2f) and 2h). You should find that according to the value of 1, consumption drops more in one case than the other, and that consumption takes longer to recover, even if the rate shock interest is the same. Explain intuit why you get a response from the consumption that is different.

If you can't answer 2F and 2H no worries!!!

(9) (10) (11) (12) (13) (14) yt = 4 + 9+ ydt = yt + rt-1bh.t-1 - ty tt = (Yt + Tt-1bh,t-1) Vt = vt-1 + ydt - Ct Ct = Qiydi + 02.0t-1 hnt = vt - bhit bd.t ydi do + dirt - 12 ve v = V+-1 + yde - C7 bht = bdt bs,t = bst-1 + (9+ + rt-1bs,t-1)-(tz + rt-1bcb,t-1) hs, t = h,t-1 + beb,t - bcb,t-1 beb,t = bs, t - bd,t ydy = ydt-1 (15) ve = (16) (17) (18) (19) (20) (21) (9) (10) (11) (12) (13) (14) yt = 4 + 9+ ydt = yt + rt-1bh.t-1 - ty tt = (Yt + Tt-1bh,t-1) Vt = vt-1 + ydt - Ct Ct = Qiydi + 02.0t-1 hnt = vt - bhit bd.t ydi do + dirt - 12 ve v = V+-1 + yde - C7 bht = bdt bs,t = bst-1 + (9+ + rt-1bs,t-1)-(tz + rt-1bcb,t-1) hs, t = h,t-1 + beb,t - bcb,t-1 beb,t = bs, t - bd,t ydy = ydt-1 (15) ve = (16) (17) (18) (19) (20) (21)