Economic Crisis and its SymptomsEconomic Crisis:A situation where a country’s economy faces aslowdown brought by a financial crisisResult: Falling GDP, increase in inflation, liquiditycrunchSymptoms:• A balance of payment crisis• Spending by a government exceeds its revenues• Rapid increase in inflation
BUILD UP OF HOUSING BUBBLE Relaxed lending Sub-Prime In 2006 Sub-prime norms, emergence of were 50% of total(Poor Credit History) non-bank independent loans issued mortgage originators MBS were rated by Mortgages were SIV converted these agencies bundled and sold to into Mortgages Backed (Moody’s, S&P), and Structured Investment Securities (MBS)were traded in market Vehicles (SIVs) These insurers wereBanks’ capital remain MBS were insured by unregulated and theirintact, they again lent Credit Default Swaps creditworthiness was it (CDS) not assessed
CRISIS Revival of General price level demand and was increasing and supply side housing prices pressure caused falling due to excess increase in price supply driven by level cheap loans Increased Interest rates and falling mortgage price BorrowersValuation of MBS defaulted, further Insurance market suffered heavily housing price Collapsed dipped
European Sovereign Debt CrisisCauses:• Rising Government Debt Levels and Maintaining High Fiscal Deficit Greece (Debt to GDP ratio of approx. 200%) Portugal & Italy (Debt to GDP ratio more than 100%)• Trade Imbalances Increase in government spending decreases the national savings thus decreases net export• Structural Problem of Eurozone• No Control on Monetary Policy
Possible effect and probable solutionEffect:• Capital Flight• Lock Out• Currency DevaluationSolution:• Increase investment and productivity• Induce economic reforms in the troubled nations
IS-LM model• It establishes the relationship between interest rates and real output in the goods and services market and the money market• The intersection of the IS and LM curves is the "general equilibrium"
Fiscal Policy & Monetary policyFiscal Policy: Government adjusts its levels of spending in order tomonitor and influence a nation’s economyExample:Fiscal expansion: An increased government spending or reductionof taxes.Fiscal contraction: A decrease government spending or increase intaxes.Monetary Policy: Central bank controls the supply of money in theeconomyExample: Monetary expansion via open market
Monetary-Fiscal policy mix: German Unification• Policy Mix: The combination of monetary and fiscal policies is known as monetary-fiscal policy mix or simply policy mix.• Fiscal Policy: The German government sharply increased government spending and transfers in order to revive eastern Germany• Monetary Policy: After implementing fiscal policy German central bank (Bundesbank) feared high possibility of inflation hence adopted tight monetary policy to slow down economic activity
Monetary-Fiscal policy mix: German Unification• IS curve from IS1 to IS2 by increasing government spending hence increasing aggregate output• The LM curve to the left from LM1 to LM2 due to tight monetary policy (Increase interest rates )• Resulted in fast growth (from the fiscal expansion) and high interest rates (from the tight
LIQUIDITY TRAP Cash additions to the private banking system by the central bank fail to lower interest ratesPeople anticipate adverse happenings like deflation, war etc. and so store cashCentral banks try to lower interest rates by buying bonds with the newly created cash
Understanding Through IS-LM Model• LM curve is horizontal• Money supply is indifferent to interest rates• Monetary policy is ineffective in changing output in the market• Fiscal expansion leads to higher output level• No change in interest rates• No crowding out
A particular slide catching your eye?
Clipping is a handy way to collect important slides you want to go back to later.