Question: Consider two hypothetical nations: Wahooland and Wildcat Island. Initially, these nations are identical in every way. In particular, they are the same with regard to population size and age, income and wealth, and time preferences. They also have the same interest rates, saving, and investment.
a. Suddenly, in the year 2015, the interest rate in Wahooland rises. After some investigating, economists determine that nothing has happened to the supply of loanable funds. Therefore, what are the possible reasons for this rise in interest rates in Wahooland?
b. Given your answer to part (a), what can you say about the level of investment in Wahooland relative to that in Wildcat Island in 2015? What can you say about future income levels in Wahooland versus Wildcat Island?
c. Often, we think of lower interest rates as always being preferable to higher interest rates. What has this question taught us about that idea?