Economic

Presented By: Group 2B

Economic Crisis and its Symptoms

Economic Crisis:A situation where a country’s economy faces a slowdown brought by a financial crisisResult: Falling GDP, increase in inflation, liquidity crunchSymptoms:• A balance of payment crisis• Spending by a government exceeds its

revenues• Rapid increase in inflation

US SUBPRIMEMORTGAGE

Sub-Prime(Poor Credit History)

Relaxed lending norms, emergence of

non-bank independent mortgage originators

In 2006 Sub-prime were 50% of total

loans issued

Mortgages were bundled and sold to

Structured Investment Vehicles (SIVs)

SIV converted these into Mortgages Backed

Securities (MBS)

MBS were rated by agencies (Moody’s,

S&P), and were traded in market

Banks’ capital remain intact, they again lent

it

MBS were insured by Credit Default Swaps

(CDS)

These insurers were unregulated and their creditworthiness was

not assessed

BUILD UP OF HOUSING BUBBLE

Increased Interest rates

and falling mortgage

price

Revival of demand and supply side

pressure caused increase in price

level

General price level was increasing and

housing prices falling due to excess

supply driven by cheap loans

CRISIS

Borrowers defaulted, further

housing price dipped

Valuation of MBS suffered heavily

Insurance market Collapsed

European Sovereign Debt Crisis

Causes:• Rising Government Debt Levels and

Maintaining High Fiscal DeficitGreece (Debt to GDP ratio of approx.

200%) Portugal & Italy (Debt to GDP ratio

more than 100%) • Trade Imbalances

Increase in government spending decreases the national savings thus decreases net export• Structural Problem of Eurozone• No Control on Monetary Policy

Possible effect and probable solution

Effect:• Capital Flight• Lock Out• Currency DevaluationSolution:• Increase investment and

productivity• Induce economic reforms in the

troubled nations

IS-LM model• It establishes the

relationship between interest rates and real output in the goods and services market and the money market

• The intersection of the IS and LM curves is the "general equilibrium"

Fiscal Policy & Monetary policy

Fiscal Policy: Government adjusts its levels of spending in order to monitor and influence a nation’s economyExample:Fiscal expansion: An increased government spending or reduction of taxes.Fiscal contraction: A decrease government spending or increase in taxes.

Monetary Policy: Central bank controls the supply of money in the economyExample: Monetary expansion via open market

Fiscal Expansion

Fiscal Contraction

Monetary-Fiscal policy mix: German Unification

• Policy Mix: The combination of monetary and fiscal policies is known as monetary-fiscal policy mix or simply policy mix.

• Fiscal Policy: The German government sharply increased government spending and transfers in order to revive eastern Germany

• Monetary Policy: After implementing fiscal policy German central bank (Bundesbank) feared high possibility of inflation hence adopted tight monetary policy to slow down economic activity

Monetary-Fiscal policy mix: German Unification• IS curve from IS1 to

IS2 by increasing government spending hence increasing aggregate output

• The LM curve to the left from LM1 to LM2 due to tight monetary policy (Increase interest rates )

• Resulted in fast growth (from the fiscal expansion) and high interest rates (from the tight monetary policy).

LIQUIDITY TRAP

Cash additions to the private banking system by the

central bank fail to lower interest rates

People anticipate adverse happenings like deflation, war etc. and so store cash

Central banks try to lower interest rates by buying

bonds with the newly created cash

Understanding Through IS-LM Model

• LM curve is horizontal

• Money supply is indifferent to interest rates

• Monetary policy is ineffective in changing output in the market

• Fiscal expansion leads to higher output level

• No change in interest rates

• No crowding out

THANKS