The following sub-questions are about liquidity management and asymmetric information problems in the financial system and their effect on economic activity.
a) Explain how a bank facing a sudden deposit withdrawal solves the problem of liquidity. What are the costs related to each case? [6 marks)
b) Consider the situation where balance sheets of banks are growing worse and because of this, these banks are failing at the same time. How does such a condition affect economic activity? [6 marks]
c) Changes in what financial variable indicate that asymmetric information problems in the financial sector are increasing? [6 marks]