Financial crisis.docx

1、Financial crisisIntroduction:Financial crisis started from America and soon spread all over the world. How did this happen? What government has done to rescue the economy and what should we do to help? Is financial crisis inevitable? These questions have bothered me for a long time. However, if we u

2、se a macroeconomist eye to view the world, all the questions seemed clear and crystal. 1. Causes and impact of the current financial crisisTo help the economy walk out from deflation in 90s, American government decided to stimulus the property market. Fed had cut short - term interest rates 12 times

3、, from 6.5 percent to 1.25 percent. (P17 Bailout) And American banks also carried out the basic 30 -year fixed - rate mortgage. (P23 Bailout) The low interest rate and good mortgage policy makes property companies built more houses and ordinary people have easier access to buy a house. When American

4、 Federal Reserve gives a bond rate for only 1%, investors no longer want to buy bonds. But they have to find another way to invest. Investors soon figure out that they can make money from property.Here is how it works. Investment bankers buy mortgage from mortgage lender. Then they pack the mortgage

5、 into a CDO box and sell the box to investors. Investors make great money from CDO and soon they want more mortgages.Since the house price seems rising forever and the mortgage lender will have the house even if the house owners default their house, so the mortgage lender add risks when packing a CD

6、O box. They turn the market target towards sub primes. But these sub primes are like invisible bomb hidden in the CDO box and this is where crisis began. Sub primes have no income insurance or down payment, when sub primes cant afford their houses, they just left the house. Thousand of sub primes ca

7、nt afford their house and these defaulted houses created a surplus in property market and push house price down. For those home mothers still pay the mortgage, it is worthless for them to keep the house. House price went down continually because house supply is much exceeds house demand. Figure (1)

8、According to figure (1). From 2007, the subprime crisis has emerged and American property received a huge decline in 2008. 2008 is exactly when lots of American investment banks went bankrupt.Property market froze up. Mortgage lenders no longer lend out money, house wives wont buy house any more and

9、 investment bankers also dont want mortgages. But even so, the pace of crisis had already been unstoppable. Because the investment bankers and mortgage lenders had a lot sub primes in hand and leverage in property market n-tupling the effect. Money slows down the flowing speed in the market. Multipl

10、ier effect expands the crisis in property market. Because when you stop buying houses, furnitures and other house decorations market would crash too. Consumer confidence drops down quickly. Companies began to fire workers because demand of the market decreased. Unemployment rate rose rapidly and emp

11、loyees bargaining power went down. Income went down, people consumed less and less. Output of firms and companies went down continually and unemployment rate rose up synchronous. Like a snow ball, the whole economy is in a downward spiral.2. Relationship between the financial crisis and the followin

12、g equationY=C0+C1(Y-T) +I+G and I=I(Y (+), i (-). Real GDP of America Figure (2) P90 of World Economic Outlook 09 APRFrom figure (2), we can see clearly that from 2007 to 2009, American real GDP received a huge decline, which is obviously affected by subprime crisis. The subprime crisis made banks w

13、ent bankrupt and stopped the credit multiplier. Investment went down quickly, which directly influence the output of America. Interest rate Figure (3) From 2007 to 2008, Federal Reserve lowered down the interest rate aiming at stimulus consumption and investment. When the financial crisis took place

14、, the economy was too cold, so the Federal Reserve had to keep the interest rate at a low level. Government spendingFigure (4) From the data we can see that US government increased the spending in order to stimulus the economy. . Disposable income Figure (5) www.bea.gov Disposable income also reacte

15、d in the same pattern.If we put all of these data together into the equation, we can easily draw the conclusion that GDP in 2007 is higher than 2009s, associated with higher disposable income, higher interest rate, lower government spending and more investment. In 2009, the economy began to recover

16、because governments expansionary monetary and fiscal policy. 3. The importance of macroeconomic multipliers on credit crisisBanks will have a certain amount of money to reserve, lets suppose the reserve ratio is 10%. Central bank has $1000 cash, then it can loan out $900. Investment bank A borrowed

17、$900 from this central bank and loan out $810 to John who used the money bought a computer. The computer manufacture deposit $810 in investment bank B. Mark borrowed $729 from investment bank B to buy a washing machine. Then the washing machine manufacture deposit $729 in investment bank C, so this

18、bank can loan out $656.1. As the multiplier goes on and on, the $1000 cash in the central bank can create $10000.But the fractional banking system is based on credit. The money banks lend out is far exceeding the deposited money because banks believe that consumers wont come and withdraw money all t

19、ogether. If consumers havent pay their loan on time and the other consumers confidence towards banks dropped down, the whole multiplier process will slow down even stuck in one point. What worse, if the run on banks take place, banks will go bankrupt. This directly stop the flowing of money, thus, s

20、top the multiplier. Thats when financial crisis happens.Multiplier does not simply base on credit; its also related with consumption. The subprime crisis drew the consumers confidence down, people purchase less and less. Even just one person cut down his budget; the multiplier he causes is huge. Sup

21、posed John planed to buy a new car early in 2008. But his houses value is declining in the middle of 2008. So John gave up the plan of buying a car. The salary of a car salesman, Mark, went down. Reluctantly, Mark cannot buy the air conditioner he has been longing for a long time. Kelly, a saleswoma

22、n of air conditioner, cannot afford the bike for her sons birthday. This situation will goes on and on, like a snow ball, bigger and bigger. Since demand goes down, output will also goes down.Actually, consumption and credit are not separated, they affect each other. Together, these two elements cau

23、se a huge multiplier which leading the whole economy whether into a boom or crisis.4. Relationship between Americas fed rate and financial crisis Figure (6) www.research.stlouisfed.org Graph (1)Graph (1) is based on the data in figure (2) and drew by Excel. From the graph we can see clearly that fro

24、m the autumn time of 2007 to winter time of 2008, the fed rate dropped down rapidly. This represent from 2007 to 2008, American banks reserve ratio went down synchronously. Because reserve ratio went down, the interest rate also went down. For America, property market had an easier access to get mon

25、ey. The rapid flow of money expands the effect of credit multiplier. When the subprime crisis began to emerge, the market already had a huge number of useless bank account. Credit froze up, because the low interest rate, multiplier made the situation worse. When the economy began to recover, consume

26、rs confidence were still in a low level. Federal Reserve had nothing to do but kept the fed rate low in order to make the interest rate low and stimulus the economy.5. Relevance of Americas and Chinas MPC, MPS to financial crisis Chinas MPS is relatively high, maybe its because the traditional way o

27、f using money is to save them for a rainy day. And compared with America, Chinese welfare is not so solid. We have to pay the medical insurance. For those adults who have family, parents should purchase their childrens education fees and support their parents. America, on the other hand, MPC is quit

28、e high. The reason, I think, is that Americans have a strong belief in their societys financial situation. Sometimes, overestimate the situation. The majority of American use credit card to consume. Credit overdraft, leverage is not uncommon in American.Figure (7) www.oecd.org It is a fact that Amer

29、icans consume much more than they save, and they borrow a lot to buy cars and houses. From figure (3) we can easily draw the conclusion that American do spent a lot. In the year 05 06 07, the saving rate even lower than 1%. Then where do they get so much money? Yes, from our developing countries whi

30、ch save a lot but spend a little. China, as one of the greatest debtee of America, suffers a lot from this financial crisis.It dose make sense why financial crisis cause such a huge impact to America. For a countrys economy, the more credit they use, the more multiplier will be created and the more

31、risks this country will undertake. 6. My opinion about American governments bail out plane for financial sector and justifications of moral hazard may be usefulI think American government should give bail out plane to those banks in danger. For banks are the start of credit, credit creating multipli

32、ers and multipliers keep the whole economy running in a rapid speed. If government doesnt give support to banks which are in danger, the whole economy will be in a danger, and social problems: social insecurity, increasing rate of criminal even revolution will occur in the same time. Bail out plane indeed has positive effect toward the economy, but we cant ignore the negative effect. To a certain degree, bail out plane reduces the risks in Ameri