Sample Essay

Asymmetric information exists in those circumstances when it is not possible for the state to analyze and identify the integrity of all its financial intermediaries. It is not possible for the central authority to monitor each and every action that takes place or information that passes through the intermediary. This puts the integrity of the financial intermediary at a risk. In such cases the financial strength of the intermediary cannot be accurately ascertained. The failure of the intermediary as a result can be a drawback for the economy and the monetary market creating a debt spill. “This incorporates a debt contracting problem with asymmetric information into a standard monetary business cycle model. The model incorporates a limited participation assumption in order to induce a liquidity effect of monetary shocks and propagate monetary disturbances. The model economy shows that a positive money supply shock generates a decrease in nominal interest rates and an increase in output level. Asymmetric information amplifies the response of capital to the money supply shock, but does not propagate them in other ways. When the monetary shock is an innovation in reserve requirements, it induces a persistent response of the economy.” (Cooley, 1998)

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