Gdp Laos

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Economics and financial crisis

Economics

 

• 
  Assume that the money market is initially in equilibrium for an economy. Explain with the aid of a diagram how the market adjusts to:
  
  
  • an increase in money supply (250 words)
  
  
  • an increase in real GDP (250 words)
  
  
  
  

Answer

 

• An increase in money supply:

 

At the point F the economy is at equilibrium. The GNP level is at Y1 and the exchange rate is E$/£1. Now, assume if the money supply increases, the change or an increase in the money supply will cause AA shifts up for example ↑MS is the reason for AA-up-shifts. Same as shown in the diagram, through an upward movement of Red AA to Blue A'A' curve.

• Due to the upward movement in AA results in the shift of equilibrium from F to H point.


• To adjust the equilibrium at point H, the GNP increases to Y2 from Y1 and accordingly the exchange rate even increased to E$/£2 from E$/£1.


• Current Account balance will increase as Final equilibrium point i.e H is above the iso-CAB (CC) line. Means if the CC is in deficit then the deficit falls and if the CC is in surplus i.e point F then the surplus increases.

 

• At the G point the economy was at the left of the curve DD but it goes to right side above the curve A'A' due to the GNP rise in the economy. At the last economy gets settle stepwise at point H from point G with a decrease in exchange rates at A'A' curve. It will go on till the economy gets the equilibrium at H-point.

 

Thus, this is notable that the increase in money supply indicates the real supply of money has gone beyond the real demand of money. Now, as we know the business people have more money they will start converting the liquid money to non-monetary assets. This will bring the raise in supply of fixed deposits in the banks and the interest rates will go lower.   And exchange rates E$/£, will go high. This movement from F to G point is shown in DD-AA graph. The curve AA goes up and shows the asset market equilibrium and high money supply. Now, as the foreign exchange and money markets can adjust instantly to the changes of money supply, the Economy will not remain stick to A'A' curve for long time.

 

 

• An increase in real GDP:

 

Assume that point A in the graph is the market equilibrium. MS/P$ is the Real Money Supply and i$' is marked as Interest Rate. If Y$, the real GDP goes up then MS (Money Supply) and P$ (Price Level) will remain stable. If GDP increases the money demand will raise up. This shift is shown in the shift of L(i$, Y$") from L(i$, Y$').

 

At i$' the interest rate, the real money demand is raised from 1 to 2 while the real money supply is stable at 1 only. It simply means that the real money supply will decrease from real money demand not only this but the interest rates will also decrease than the equilibrium market rate.

 

At the final stage the equilibrium will be at B as shown in the diagram. Now, when interest rates gets higher to i$'' from i$', the demand of money will fall down to 1 from 2. Hence, the economic growth or an increase in real GDP will result an escalation in the interest rates of an economy. While on the other hand if the real GDP decreases which is also known as recession period, will result reduction in the average interest rates of an economy.

 

 

• Choose an economy of interest to you and answer the following question:

(1000 words max)

• What measures did the country's central bank adopt in the 2008 period, in the face of the worsening global financial crisis? Name 2-3 key measures & describe briefly how it was implemented.


• Which of these measures were effective? Which ones were not? Provide an economic explanation of why do you think so.

Answer:

The global financial crises affected the House Mortgage market badly and led towards the Economic recession during 2007-2009. It was regardless of the sound financial policies and globalization in a country the financial crises of September-2008 affected each and every country's economy. The liquidity transmission and decreasing prices of assets led towards the solvency in most of the Central Banks. These Banks were now running towards prioritizing the credit and quantitative easing. The Fiscal and monetary policies of emerging economies were after ordering the functions of market and its moderation to sustain the financial stability.

 

Table: 1 - Emerging Economies

 

Argentina

Brazil

Bulgaria

Iceland

India

Indonesia

Poland

Romania

Russia

Chile

Israel

Saudi Arabia

Kazakhstan

Korea

Latvia

Colombia

South Africa

Lithuania

Thailand

Costa Rica

Malaysia

Turkey

Ukraine

Uruguay

Vietnam

Mexico

Nigeria

Pakistan

Peru

Philippines

Croatia

Czech Republic

Egypt

Estonia

Hungary

China

People's Rep. of Hong Kong SAR People's Republic of China

Serbia Republic of Singapore

Source: IMF, Monetary and Capital Markets Department.

Below given are the emerging economies apart from Argentine, Bulgaria, Costa Rica, Estonia, Lithuania, Pakistan, Singapore, and Vietnam

 

Source: The estimations of Bloomberg and other authors

 

Below given is the trade cycle of India that was affected badly during 2008:

 

Source : www.rbi.org.in

 

I would refer the Indian Economy here and will refer the measures adopted by the central Bank in India known as Reserve Bank of India. Like other central banks in the world, the Reserve bank of India took multiple conventional and unconventional measures to increase foreign exchange rate as well as domestic liquidity and the policy rates. During the period from October 2008 to April 2009, there were many new policies implemented. Such as:

• CRR - The Cash Reserve Ratio was brought down by 5 % from its basic points


• RR - The Repo (Repurchase) Rate was diluted to 4.75 %


• RRR - The Reserve Repo Rate was also reduced to 3.25 %

In such worsening global financial crises Central Banks have to adopt some conventional and unconventional measures, few of them are given below along with the description how they were implemented:

 

• Alleviating Domestic Liquidity Measures

To ease the domestic liquidity following measures were adopted

 

1. Direct Instruments: The central bank reduced the domestic reserve requirement ratios to ease the shortages of domestic liquidity, along with averaging the reserve and raising the exemption limits.


2. Arrangements for Systematic Domestic Liquidity:  Easing the conditions for market base liquidity facilities such as increasing the auctions, broadening maturities, decreasing the collateral concessions etc.


3. Measures by Government Directly: Government took the active participation in providing liquidity by government security deposits in banks, differing the tax payments etc.

 

• Alleviating Foreign Exchange Measures

This measure involved the in-depth analysis and reforms in the sector of Foreign exchange and the involvement of foreign investments in the domestic finance market. Hence following measures were adopted.

 

1. Involvement of Foreign Exchange Liquidity: The central banks introduced many new foreign exchange policies such as swap facilities and dollar repurchasing.  The liquidity limits for foreign exchange were relaxed now and the ceiling limits were removed. The foreign currency that was deposited in the overseas banks now shifted to the domestic banks. Some of the central Banks even decreased the taxes on foreign exchange transactions and lowered down the reserve foreign currency ratio.


2. Arrangements for swap of Cross central bank currency: The Federal Reserve made the arrangement to swap the dollars  with the central banks of Singapore, Korea, Brazil and Mexico, on the other hand other European countries and Swiss Bank offered the Euros to Hungary and Poland. By doing so they can provide the foreign exchange to the domestic parties or can increase the trade credits.

 

By adjusting liquidity with exchange rate and non- turbulent local debt market, the Reserve Bank of India managed the liquidity system and sustained the financial stability.

 

This is for sure that by making such valuable measures the central banks have played an important role to face the economic crises during the period of 2007-2009. The Liquidity Alleviation Measures by central banks brought the effective reforms. The trust of the corporate sectors and financial in many of emerging economies on foreign funding leaves them conquerable to a cutoffs of such financing, with serious backlashes for economic activity. This vulnerability can guarantee short-term foreign exchange and domestic liquidity provisions on financial stability bases. However, extended liquidity easing may be harmful because emerging economies are prostrate to large and potentially unstable capital outflows. Cross-central bank swap appears to be very appropriate and helpful, but their planning can not be under control of liquidity receiving economies. Direct government instruments, such as reserve requirement changes may also be effective but can have negative fallouts as well. The fiscal authorities can deal with the credit policies better in comparison with the central bank.

 

The credit and quantitative easing is less effective for most of the emerging economies. First, the fiscal crises has been less severe and inflation was higher severe, so only few countries can adopt the downsizing interest rates. Second, the helplessness of emerging economies towards outside blows required that policy rates to be kept at adequate stage so that it can cover currency occupants for risk related to exchange rates.

 

The Effects of the timely measures were really very positive and sustained the Indian Economy as visible in the below given graph:

 

 

Source: www.rbi.org.in

References

 

1. World Bank (2009) ―Latin America beyond the Crisis: Impacts, Policies, and Opportunities


2. Reserve Bank Of India – www.rbi.org.in
   


3. "Rapid, qualitative assessments of the impacts of the economic crisis: Overview of findings from eight countries" (Vietnam, Thailand, Cambodia, Lao PDR, Mongolia, Ghana, Romania and Turkey)


4. "How Many More Infants are Likely to Die in Africa as a Result of the Global Financial Crisis?" by Norbert Schady and Jed Friedman. World Bank Policy Research working paper, WPS 5023.


5. Margaret Grosh, C. (2008). For Protection and Promotion: The design and implementation of effective safety nets. Washington, D.C.: World Bank.

 

 

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