Financial crisis.docx

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