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Suppose people in our overlapping generations model have the opportunity either to hold ?at money with complete safety or to lend to someone who may never repay the loan. The chance of such a default is 10 percent. Assume a stationary monetary equilibrium in which the population grows at a net rate of 8 percent and the ?at money stock is ?xed. What real interest rate will be charged to the borrower if people are risk neutral? What can you say about the level of the real interest rate if people instead are risk averse?

Microeconomics, Economics

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