This homework is about the banking system and interest rate transmission. 2. Assume the following empirical regularities regarding various interest rates in the economy: Ains (t) = 0.6* Aita (t-1) + 0.4* Aica (t-1) - 0.5* [i. (t-1) - ice (t-1)] Aiza (t) = 0.4* Aira (t-1) + 0.6* Aica (t-1) - 1.0* [ija (t-1) - ica (t-1)] where is (t) = Treasury bill interest rate in period t, ic (t) = central bank policy interest rate in period t, i= (t) = interbank money market interest rate in period t, and Ax(t) = x(t) - x(t-1) = one period change in variable x. Answer the following questions using this information. a) What are the initial steady-state equilibrium values of is (t) and ix (t) in this economy? What do they indicate about the slope of the steady-state yield curve and effectiveness of the policy interest rate to anchor money market and Treasury market interest rates? b) Assume that initially the policy interest rate equals 4% (for period t = 0,-1, -2, and so on). Suppose that the central bank lowers its policy interest rate by 1% permanently in period t =1. What are the initial effects of the policy easing on the two market interest rates. What can you say about the adjustment speed in the two market interest rates? Explain. c) Excel question] Illustrate the dynamic adjustment in the two market interest rates in response to the above permanent easing of monetary policy (for number of time periods needed to achieve convergence is about 40). Show your charts and discuss differences in the two adjustment paths. d) Assume further that commercial banks' deposit interest rates are tied fifty-fifty to the Treasury bill interest rate (time deposits) and the money market interest rate (demand deposits). Suppose that deposit liabilities total $1,000. What is funding cost in the initial steady-state equilibrium and how will it change in response to the This homework is about the banking system and interest rate transmission. 2. Assume the following empirical regularities regarding various interest rates in the economy: Ains (t) = 0.6* Aita (t-1) + 0.4* Aica (t-1) - 0.5* [i. (t-1) - ice (t-1)] Aiza (t) = 0.4* Aira (t-1) + 0.6* Aica (t-1) - 1.0* [ija (t-1) - ica (t-1)] where is (t) = Treasury bill interest rate in period t, ic (t) = central bank policy interest rate in period t, i= (t) = interbank money market interest rate in period t, and Ax(t) = x(t) - x(t-1) = one period change in variable x. Answer the following questions using this information. a) What are the initial steady-state equilibrium values of is (t) and ix (t) in this economy? What do they indicate about the slope of the steady-state yield curve and effectiveness of the policy interest rate to anchor money market and Treasury market interest rates? b) Assume that initially the policy interest rate equals 4% (for period t = 0,-1, -2, and so on). Suppose that the central bank lowers its policy interest rate by 1% permanently in period t =1. What are the initial effects of the policy easing on the two market interest rates. What can you say about the adjustment speed in the two market interest rates? Explain. c) Excel question] Illustrate the dynamic adjustment in the two market interest rates in response to the above permanent easing of monetary policy (for number of time periods needed to achieve convergence is about 40). Show your charts and discuss differences in the two adjustment paths. d) Assume further that commercial banks' deposit interest rates are tied fifty-fifty to the Treasury bill interest rate (time deposits) and the money market interest rate (demand deposits). Suppose that deposit liabilities total $1,000. What is funding cost in the initial steady-state equilibrium and how will it change in response to the
