Macro Economics questions (Other (Not Listed) Sample)

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Macroeconomics Questions
Characteristics of Financial Industry That Created Global Economic Crisis
Most analysts note that although the global economic crisis was avoidable, the government and financial institutions are to blame. There were bubbling market prices, due to speculations that the values of estates and houses could continue to rise. The bubbling was accelerated by the fact that there was easy credit, which people ignorantly borrowed to finance their purchases through mortgages. When many of the purchasers could not afford the loans, many defaults could lead to general panic in the market. Moreover, it has been argued that subprime lending played a big role in precipitating the situation. Since subprime lenders did not operate in the mainstream commercial banking sector, the Fed could not regulate them. Being operated by largest investment banks in the US, they relaxed net capital rule and aggressively, because of competition among themselves to sway customers, they easily dished out credits. The same was the case in mortgage underwriting where rules were relaxed. Nonetheless, the crisis was attributed to the culture of predatory lending whereby unscrupulous individuals entered into unsound or unsafe lending businesses for inappropriate purposes.
Gains and Losses in Magnified Leverages
With leveraging, one would magnify the losses and gains he could make by usually borrowing more money on an asset so that he can increase the amount it was purchased. In this regard, financial institutions during that time became highly leveraged and, therefore, they increased their appetite for investments that were very much risky. The investors were not keen to apply appropriate resilience, in case they could turn out to be losses. It is important to note many off-balance sheet situations made it difficult for financial regulators to monitor and show exact values of some assets. Moreover, it was difficult to reveal whether commodities were in bankruptcy or not, leaving their sellers to overcharge them. In the year 2007, the top five investment banks had increased their leverages with hopes that they would be optimal. When borrowers defaulted to pay the highly priced investments, a significance crunch caused the economy to begin shaking.
Roles of Risks and Ignorance on the Market
For ignorance, it has been noted that since nobody knew the prices of various portfolios on the market, they were valued in relation to prices of other products. Since some transactions happened within the domain of investment banks, nobody could trace them and, therefore, there was a tendency to relax on Fed’s lending rules. Moreover, during this period, the financial industry experienced many financial innovations that were too complex for the common investor to understand.
According to the Congress’ report on causes of recession, risky management of financial institutions and individuals being irresponsible about their investment ventures contributed a lot in a recession. Most Americans bought homes without noticing how the interest was growing; they were not willing to cope up with borrower-lender ethics. On the other hands, there were easy bank credit conditions that encouraged people to enter into risky transactions. Nevertheless, cases of predatory lending where individuals entered into unsound and unsafe credit transactions became very common.
Deregulation and Its Impacts on Banking Behavior
Most economists believe that the Fed’s decision to start deregulating financial institutions so that they could regulate themselves was one of the major contributors to the economic crisis. It began when the former Fed chairperson, Alan Greenspan, stripped off key safeguards that could have helped to prevent a catastrophe. When the government left firms to choose their regulators, as analysts say, it became the source of catastrophe. In this case, financial corporations acted recklessly, taking many risks while with little capitals. Economists have argued that the country’s regulatory framework did not also keep pace with innovations in the financial sector. It led to the increased harmful shadow banking activities and off-balance sheet activities by investment bankers, which were not regulated. Moreover, several US legislations such as the Carter’s Depository Institutions Deregulation and Monetary Control Act relaxed the regulatory framework, and, therefore, it increased unconventional business activities.
The Role of Contagion -Spreading Failures, in the Financial Collapse Of 2008
The global financial contagion begun in the United States in 2007 and went on to spread to other parts of the world. In this regard, it came about due to profound upheaval in the US credit markets, after the collapse of major investment houses like Bear Stearns, quickly catching the entire economy and spreading to other major economies around the world. It became a global effect, when most countries begun experiencing rapid economic contractions.
US Government Interventions Since 2008
Most countries intervened by expanding their money supplies in a bid to avert the ongoing deflationary spirals. Governments have also been enacting various fiscal packages to stimulate their economies. Others have set up a pretty program of borrowings and spending to offset the decreased demand that the crisis had caused. Between 2008 and 2009, the US executed two stimulus packages that totaled nearly $1 trillion. Moreover, the governments have been purchasing debts in insolvent firms such as General Motors in exchange with its preferred stocks. Some governments have printed more money so that they can combat liquidity trap. While the government has been bailing out some firms, they have been encouraged to purchase foreign currencies so that they can avoid the contagion effects in case the next crisis starts with US dollar effect.
Describe and Draw the Graphs for These Strategies
Graph 1
Graph 2
In the graph 1, stimulus packages involved monetary expansions, which have been executed by both the government and the Fed to stimulate aggregate demand in the whole economy and therefore employment. In this respect, as the money supply increases, the real interest rate will fall, and as it falls, aggregate demand will increase which will be shown by the original aggregate demand curve moving to the left (in the position of the new aggregate demand). Moreover, as the prices begin to rise (from 105 to 110), producers will be motivated to begin producing more and, therefore, the output will be higher in the long run, increasing employment. However, in graph 2, it is important to note that the long run GDP will be inelastic as shown in the second graph due to static limit of natural resource endowments and full production capacities of firms.
Strategies- Tight or Easy Monetary and Fiscal Policies
Tight monetary and fiscal policies will restrict the money supply while loose policies will be accommodative, allowing easy expansion of credits. The tight policies are good when the economy is growing too fast, being accompanied by skyrocketing inflation and, therefore, the central banks will have to apply them to cool it down. Conversely, when the economy is staggering, the central bank can apply loose policies to lower short-term interests so that the economy can be stimulated to get back on track. In this regard, as already discussed, since the economy was in recession, loose policies were recommendable to put it back on track. According to the Congressional report of 2011, stimulus package was a major success to the US economy as it saved major American corporations that were collapsing. However, when the economy begins moving too fast, tight policies will be recommendable.
The Gross Debt and the Net Debt and Tax Payers
Gross debt is measured as the debt held in different accounts of the federal government that includes trust funds and the debt the public holds. A net government debt is only held by the public. Since the government debt is normally intra-governmental, it is considered to have a lesser effect on the economy. Therefore, the net debt has a greater effect on the open economy and hence, the future taxpayers of the country.
Solvency Conditions and Averting Debts Challenges
Solvency refers to the ability for an entity to meet most of its long-term financial obligations. For a firm, there are various financial ratios (tools) used to determine whether it is solvent or not for instance, the debt-to-equity ratio among others. Therefore, it is important that the debt-equity-ratio not emerge as over one.
At government level, solvency conditions can be determined in five ways: cash solvency, budget solvency, long-run solvency, service level solvency and state fiscal condition solvency. In this regard, cash solvency demands that the state have enough cash to clear its bills. For budget revenue, the state should have enough revenues to cover all expenditures on its budget. Long-run solvency is used to determine how long the government will take to cover most of its costs. For service solvency, the government should have enough resources to provide services to its citizens. State fiscal condition index incorporates all ...