Question

1a) Suppose that after living through the great recession of 2007-2009, people decide to save a greater percentage of their incomes. How do this impact the loanable funds market and the aggregate demand curve??

b) What is a shadow bank? How did Shadow bank contribute to the severity of the great recession?

Answer 1

a)

During the great recession of 2007 - 2009., there was a massive slide in consumer confidence. Hence, people went for huge savings since they were pessimistic about future income. it increased the supply of money in the market. Hence, there was significant fall in interest rate.

Rise in saving reduces the expenditure of consumers. thus Aggregate demand comes down heavily.

Following is a diagram:

SRAS AD AD Yp Real GDP Price Level

In the above diagram, the demand curve shifts to left AD1 after rise in savings and fall in demand. It causes a fall in output level as well. A slowdown in output caused a substantial rise in the unemployment rate

b)

Shadow banking refers to financial institutions that act like banks but not fully. These are not fully regulated by the Federal Reserve either. These institutions do not have access to the lending window of the Federal Reserve. Further, Federal Reserve measures might be rendered less effective if the importance of shadow banking increases significantly in the economy.

during the recession, these shadow banks crumbled rapidly as these were not protected through the depository insurance. Hence, these institutions could not withstand the bank run. Thus, the recession was further deepened by these institutions.