1. Financial frictions are often described in terms of an “interest-rate spread” between a standard government debt (like the 3-month or 10-year treasury bonds) and private debt (like commercial paper, corporate bonds, etc). When would this “interest-rate spread” be high or low? Why?
2. How can financial frictions worsen a recession by undermining monetary policy? Explain this with an IS-MP diagram that incorporates financial frictions.
3. Show how financial frictions can be interpreted as a demand shock to an economy.