Financial crisis.docx
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Financialcrisis
Introduction:
FinancialcrisisstartedfromAmericaandsoonspreadallovertheworld.Howdidthishappen?
Whatgovernmenthasdonetorescuetheeconomyandwhatshouldwedotohelp?
Isfinancialcrisisinevitable?
Thesequestionshavebotheredmeforalongtime.However,ifweuseamacroeconomisteyetoviewtheworld,allthequestionsseemedclearandcrystal.
1.Causesandimpactofthecurrentfinancialcrisis
Tohelptheeconomywalkoutfromdeflationin90s,Americangovernmentdecidedtostimulusthepropertymarket.Fedhadcutshort-terminterestrates12times,from6.5percentto1.25percent.(P17Bailout)AndAmericanbanksalsocarriedoutthebasic30-yearfixed-ratemortgage.(P23Bailout)Thelowinterestrateandgoodmortgagepolicymakespropertycompaniesbuiltmorehousesandordinarypeoplehaveeasieraccesstobuyahouse.
WhenAmericanFederalReservegivesabondrateforonly1%,investorsnolongerwanttobuybonds.Buttheyhavetofindanotherwaytoinvest.Investorssoonfigureoutthattheycanmakemoneyfromproperty.
Hereishowitworks.Investmentbankersbuymortgagefrommortgagelender.ThentheypackthemortgageintoaCDOboxandselltheboxtoinvestors.InvestorsmakegreatmoneyfromCDOandsoontheywantmoremortgages.
Sincethehousepriceseemsrisingforeverandthemortgagelenderwillhavethehouseevenifthehouseownersdefaulttheirhouse,sothemortgagelenderaddriskswhenpackingaCDObox.Theyturnthemarkettargettowardssubprimes.ButthesesubprimesarelikeinvisiblebombhiddenintheCDOboxandthisiswherecrisisbegan.
Subprimeshavenoincomeinsuranceordownpayment,whensubprimescan’taffordtheirhouses,theyjustleftthehouse.Thousandofsubprimescan’taffordtheirhouseandthesedefaultedhousescreatedasurplusinpropertymarketandpushhousepricedown.Forthosehomemothersstillpaythemortgage,itisworthlessforthemtokeepthehouse.Housepricewentdowncontinuallybecausehousesupplyismuchexceedshousedemand.
Figure
(1)
Accordingtofigure
(1).From2007,thesubprimecrisishasemergedandAmericanpropertyreceivedahugedeclinein2008.2008isexactlywhenlotsofAmericaninvestmentbankswentbankrupt.
Propertymarketfrozeup.Mortgagelendersnolongerlendoutmoney,housewiveswon’tbuyhouseanymoreandinvestmentbankersalsodon’twantmortgages.Butevenso,thepaceofcrisishadalreadybeenunstoppable.Becausetheinvestmentbankersandmortgagelendershadalotsubprimesinhandandleverageinpropertymarketn-tuplingtheeffect.Moneyslowsdowntheflowingspeedinthemarket.
Multipliereffectexpandsthecrisisinpropertymarket.Becausewhenyoustopbuyinghouses,furniture’sandotherhousedecorations’marketwouldcrashtoo.Consumerconfidencedropsdownquickly.Companiesbegantofireworkersbecausedemandofthemarketdecreased.Unemploymentrateroserapidlyandemployees’bargainingpowerwentdown.Incomewentdown,peopleconsumedlessandless.Outputoffirmsandcompanieswentdowncontinuallyandunemploymentrateroseupsynchronous.Likeasnowball,thewholeeconomyisinadownwardspiral.
2.Relationshipbetweenthefinancialcrisisandthefollowingequation
Y=C0+C1(Y-T)+I+GandI=I(Y(+),i(-))
.RealGDPofAmerica
Figure
(2)P90ofWorldEconomicOutlook09APR
Fromfigure
(2),wecanseeclearlythatfrom2007to2009,AmericanrealGDPreceivedahugedecline,whichisobviouslyaffectedbysubprimecrisis.Thesubprimecrisismadebankswentbankruptandstoppedthecreditmultiplier.Investmentwentdownquickly,whichdirectlyinfluencetheoutputofAmerica.
.Interestrate
Figure(3)
From2007to2008,FederalReservelowereddowntheinterestrateaimingatstimulusconsumptionandinvestment.Whenthefinancialcrisistookplace,theeconomywastoocold,sotheFederalReservehadtokeeptheinterestrateatalowlevel.
.Governmentspending
Figure(4)
FromthedatawecanseethatUSgovernmentincreasedthespendinginordertostimulustheeconomy.
.Disposableincome
Figure(5)www.bea.gov
Disposableincomealsoreactedinthesamepattern.
Ifweputallofthesedatatogetherintotheequation,wecaneasilydrawtheconclusionthatGDPin2007ishigherthan2009’s,associatedwithhigherdisposableincome,higherinterestrate,lowergovernmentspendingandmoreinvestment.In2009,theeconomybegantorecoverbecausegovernment’sexpansionarymonetaryandfiscalpolicy.
3.Theimportanceofmacroeconomicmultipliersoncreditcrisis
Bankswillhaveacertainamountofmoneytoreserve,let’ssupposethereserveratiois10%.Centralbankhas$1000cash,thenitcanloanout$900.InvestmentbankAborrowed$900fromthiscentralbankandloanout$810toJohnwhousedthemoneyboughtacomputer.Thecomputermanufacturedeposit$810ininvestmentbankB.Markborrowed$729frominvestmentbankBtobuyawashingmachine.Thenthewashingmachinemanufacturedeposit$729ininvestmentbankC,sothisbankcanloanout$656.1.Asthemultipliergoesonandon,the$1000cashinthecentralbankcancreate$10000.
Butthefractionalbankingsystemisbasedoncredit.Themoneybankslendoutisfarexceedingthedepositedmoneybecausebanksbelievethatconsumerswon’tcomeandwithdrawmoneyalltogether.Ifconsumershaven’tpaytheirloanontimeandtheotherconsumers’confidencetowardsbanksdroppeddown,thewholemultiplierprocesswillslowdownevenstuckinonepoint.Whatworse,iftherunonbankstakeplace,bankswillgobankrupt.Thisdirectlystoptheflowingofmoney,thus,stopthemultiplier.That’swhenfinancialcrisishappens.
Multiplierdoesnotsimplybaseoncredit;it’salsorelatedwithconsumption.Thesubprimecrisisdrewtheconsumers’confidencedown,peoplepurchaselessandless.Evenjustonepersoncutdownhisbudget;themultiplierhecausesishuge.SupposedJohnplanedtobuyanewcarearlyin2008.Buthishouse’svalueisdeclininginthemiddleof2008.SoJohngaveuptheplanofbuyingacar.Thesalaryofacarsalesman,Mark,wentdown.Reluctantly,Markcannotbuytheairconditionerhehasbeenlongingforalongtime.Kelly,asaleswomanofairconditioner,cannotaffordthebikeforherson’sbirthday.Thissituationwillgoesonandon,likeasnowball,biggerandbigger.Sincedemandgoesdown,outputwillalsogoesdown.
Actually,consumptionandcreditarenotseparated,theyaffecteachother.Together,thesetwoelementscauseahugemultiplierwhichleadingthewholeeconomywhetherintoaboomorcrisis.
4.RelationshipbetweenAmerica’sfedrateandfinancialcrisis
Figure(6)www.research.stlouisfed.org
Graph
(1)
Graph
(1)isbasedonthedatainfigure
(2)anddrewbyExcel.Fromthegraphwecanseeclearlythatfromtheautumntimeof2007towintertimeof2008,thefedratedroppeddownrapidly.Thisrepresentfrom2007to2008,Americanbanksreserveratiowentdownsynchronously.
Becausereserveratiowentdown,theinterestratealsowentdown.ForAmerica,propertymarkethadaneasieraccesstogetmoney.Therapidflowofmoneyexpandstheeffectofcreditmultiplier.Whenthesubprimecrisisbegantoemerge,themarketalreadyhadahugenumberofuselessbankaccount.Creditfrozeup,becausethelowinterestrate,multipliermadethesituationworse.
Whentheeconomybegantorecover,consumers’confidencewerestillinalowlevel.FederalReservehadnothingtodobutkeptthefedratelowinordertomaketheinterestratelowandstimulustheeconomy.
5.RelevanceofAmerica’sandChina’sMPC,MPStofinancialcrisis
China’sMPSisrelativelyhigh,maybeit’sbecausethetraditionalwayofusingmoneyistosavethemforarainyday.AndcomparedwithAmerica,Chinesewelfareisnotsosolid.Wehavetopaythemedicalinsurance.Forthoseadultswhohavefamily,parentsshouldpurchasetheirchildren’seducationfeesandsupporttheirparents.
America,ontheotherhand,MPCisquitehigh.Thereason,Ithink,isthatAmericanshaveastrongbeliefintheirsociety’sfinancialsituation.Sometimes,overestimatethesituation.ThemajorityofAmericanusecreditcardtoconsume.Creditoverdraft,leverageisnotuncommoninAmerican.
Figure(7)www.oecd.org
ItisafactthatAmericansconsumemuchmorethantheysave,andtheyborrowalottobuycarsandhouses.Fromfigure(3)wecaneasilydrawtheconclusionthatAmericandospentalot.Intheyear050607,thesavingrateevenlowerthan1%.Thenwheredotheygetsomuchmoney?
Yes,fromourdevelopingcountrieswhichsavealotbutspendalittle.China,asoneofthegreatestdebteeofAmerica,suffersalotfromthisfinancialcrisis.
ItdosemakesensewhyfinancialcrisiscausesuchahugeimpacttoAmerica.Foracountry’seconomy,themorecredittheyuse,themoremultiplierwillbecreatedandthemorerisksthiscountrywillundertake.
6.MyopinionaboutAmericangovernments’bailoutplaneforfinancialsectorandjustificationsofmoralhazardmaybeuseful
IthinkAmericangovernmentshouldgivebailoutplanetothosebanksindanger.Forbanksarethestartofcredit,creditcreatingmultipliersandmultiplierskeepthewholeeconomyrunninginarapidspeed.Ifgovernmentdoesn’tgivesupporttobankswhichareindanger,thewholeeconomywillbeinadanger,andsocialproblems:
socialinsecurity,increasingrateofcriminalevenrevolutionwilloccurinthesametime.
Bailoutplaneindeedhaspositiveeffecttowardtheeconomy,butwecan’tignorethenegativeeffect.Toacertaindegree,bailoutplanereducestherisksinAmeri