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Economic Policy Essay

2418 words - 10 pages

EC3010 - Economic Policy
Assignment 1

The nature of the ongoing financial crisis merely confirms what Economists have known for some time, namely, that the interconnectedness of global economic activity renders macro-management by single governments redundant. Their function is now to regulate markets to ensure economically efficient solutions.

Module Leader :Paul McKeown
Student Name: Chen JiaHui
Student number: G20555142

1.0 Introduction

This report argues that the ongoing financial crisis merely confirms the global political consideration what economists have known for some time. Firstly, it briefly explains how the financial crisis spread around the world in ...view middle of the document...

However, the bankruptcy petition of the investment bank Lehman Brother in 2008 has triggered emergency intervention on the part of governments to spare other institutions the same fate (Claessens 2010, p.275-281). The bankruptcy of Leman Brother would have a disastrously impact on the entire economy as they are connected to the overall economy. However, the world economy has become more interconnected. According to Claessens (2010, p.275), only five countries are affected in the beginning of the financial crisis and more countries are affected during the period of 2008 to 2009 as the world is more interconnected. Due to a interconnected economy, the financial crisis would spread around world, affecting the economies of many countries rapidly and simultaneously. Therefore, governments cannot allow them to go bankrupt. Nevertheless, government intervention did not prevent the financial crisis from influencing the overall economy and the failures of Cascading bank led to a credit shortage, which blocked investment and corporate operations, pushing the world into a deep economic recession. ( Huwart and Verdier, 2013, p128-130 )

2.1 The global financial system is inherently flawed

However, the 2007-2008 financial crisis has affected the financial market of most countries simultaneously, lead to a global economic crisis. Financial crisis is originated in the United States, nevertheless, it turns into a economic crisis in many countries as the imbalance and instability of economic globalisation. As Huwart and Verdier (2013, p128) states that ‘ The crisis seriously called into question financial globalisation, which to a certain extent amplified risks linked to banking activities and financial markets and brought about financial imbalances among leading economic powers.’ However, global financial system is inherently flawed as Minksy (1992) emphasizes that financial crisis are endemic in the capitalist system because periods of economic prosperity encourages rick-seeking activity to both lenders and borrowers, which is fundamentally risky in the financial sector. Nevertheless, this excess optimism has caused the private sector’s debt accumulation during the periods of boom, which is the main reason of the appearance of financial bubbles and economic busts.

(Minksy 1992, p6-p7) Besides, within Minksy’ hypothesis of financial instability, there are three different income-debt relation for economic units associated with a different level of risk, which are hedge, speculative, and Ponzi finance. Hedge borrowers are those who have the ability to pay obligations by their cash flows. Speculative borrowers are those who pay their liabilities by the commitments on ‘income account’. For Ponzi borrowers, their cash flows from operations are not sufficient to meet the repayment of principle and the interest caused by debts. Within Ponzi unit, they sell their assets or borrow money to pay interest, increasing liabilities and the prior commitment of future...

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