group 2 b economic crisis
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Economic
Presented By: Group 2B
Economic Crisis and its Symptoms
Economic Crisis:A situation where a country’s economy faces a slowdown brought by a financial crisisResult: Falling GDP, increase in inflation, liquidity crunchSymptoms:• A balance of payment crisis• Spending by a government exceeds its
revenues• Rapid increase in inflation
US SUBPRIMEMORTGAGE
Sub-Prime(Poor Credit History)
Relaxed lending norms, emergence of
non-bank independent mortgage originators
In 2006 Sub-prime were 50% of total
loans issued
Mortgages were bundled and sold to
Structured Investment Vehicles (SIVs)
SIV converted these into Mortgages Backed
Securities (MBS)
MBS were rated by agencies (Moody’s,
S&P), and were traded in market
Banks’ capital remain intact, they again lent
it
MBS were insured by Credit Default Swaps
(CDS)
These insurers were unregulated and their creditworthiness was
not assessed
BUILD UP OF HOUSING BUBBLE
Increased Interest rates
and falling mortgage
price
Revival of demand and supply side
pressure caused increase in price
level
General price level was increasing and
housing prices falling due to excess
supply driven by cheap loans
CRISIS
Borrowers defaulted, further
housing price dipped
Valuation of MBS suffered heavily
Insurance market Collapsed
European Sovereign Debt Crisis
Causes:• Rising Government Debt Levels and
Maintaining High Fiscal DeficitGreece (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 solution
Effect:• 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 policy
Fiscal Policy: Government adjusts its levels of spending in order to monitor and influence a nation’s economyExample:Fiscal expansion: An increased government spending or reduction of taxes.Fiscal contraction: A decrease government spending or increase in taxes.
Monetary Policy: Central bank controls the supply of money in the economyExample: Monetary expansion via open market
Fiscal Expansion
Fiscal Contraction
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 monetary policy).
LIQUIDITY TRAP
Cash additions to the private banking system by the
central bank fail to lower interest rates
People anticipate adverse happenings like deflation, war etc. and so store cash
Central 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
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