The Impacts of the Global Financial Crisis on the Global Financial System - Essay Example

Running Head: Global Financial Crisis Name Course Lecturer Date The Impacts of the Global Financial Crisis on the Global Financial System The global financial crisis was an indication of the interconnectedness of the global economies. The first indications of financial markets distress emerged in the middle of 2007. Reinhart & Rogoff (2009) reports that this was when two funds, apparently related to United States financial company, declared serious problems with their holdings of mortgage backed securities commonly known as MBS. The problems were principally severe in case of securities comprising subprime mortgages which are mortgages to individuals with a lower income or non-standard credit history. This dislocation spread like wildfire through credit markets over the second half of 2007. This was when concerns intensified about the value of MBS and other asset backed securities. Notably, securities that investors thought were low risk were downgraded sharply as assets underlying those securities suffered very sharp losses as Berkmen et al., (2009) asserts. These concerns made banks to become considerably less willing to lend to each other and also to hoard their cash holdings. Equity markets took longer than banks to be affected, their prices continued to rise until later in year 2007. This is even as bank share prices started to decline. The eventual collapsed of the subprime mortgage market in the united states combined with the housing boom in other major industrialized economies have had a ripple impacts on global financial system (Brinkman et al., 2010). Weaknesses in the global financial system twinkled in and started to surface. Some financial instruments and products became twisted and so complex that as things started to unravel, the whole financial system started to fail. The global financial crisis affected the global financial system severely. Taylor (2009) indicates that the presence of a shared driver affecting the value of assets as well as financial systems in several countries (major world economies) at once contributed to worsening of the global financial system. The interest rate, which is a major component of the global financial system, was low before the GFC. However, the financial crisis led to concerns about deflation risks following the failure of the tech bubble. It is not common to have a period of low interest rates. What was unusual, in this case, was the persistence of the interest rates across large parts of the world. It contributed to concurrent risk taking and later vulnerability in the major world economies as Shiller (2008) observes. The interest rates increased considerably. Banks took a back step in lending to each other, the interest rates charged by banks on lending to each rose to 5 percent from virtually 1 percent. Notably, the global financial system become complex after the global financial crisis, the financial systems across the world became complex. Usually, the financial systems tended to grow faster that the economies they serve before the GFC. However, after the GFC, the financial systems stagnated, they did not record growth. Instead, they started to shrink during the financial crisis. There was creation of financial wealth during and immediately after the financial crisis. This made the financial systems cross the world to record negative growth as Chor & Manova (2012) asserts. The stock markets started to drop significantly, investors were not willing to invest their money in fear that they would lose the investment just like investors lost their money during the housing bubble and the start of the financial crisis. The proportion of income that people are prepared to invest or spend on financial services tends to rise as the societies get richer and as their income increase. After the financial crisis, the societies did not have money to spend; they were not willing to spend their money even for those who had some to invest, this made the financial system to stagnate (Claessens et al., 2010). Essentially, the global financial markets almost came to a complete halt after the collapse of the Lehman Brothers; fears of instability of the global financial system became evident. Major currencies around the world depreciated as a result of the financial crisis. For instance, the United States dollar depreciated significantly by 42 percent. In addition, the Australian dollar depreciated by 30 percent (Campello et al., 2010). How Australian Policy Makers Dealt With the Problems Presented By the Global Financial Crisis The major problem that faced the Australian economy at the time and shortly after the global financial crisis was inflation. The Australian government offered a budget that directly responded to the financial crisis, aimed at fighting the inflation that was working to destroy the Australian economy as Reinhart et al., (2008) observes. Australia was not affected as much like other economies by the global financial crisis. The money and credit markets in Australia proved to be more resilient than other major economies. This necessitated substantially less intervention by the reserve bank of Australia. In large parts, the less intervention by RBA reflected the health of Australian banking system and economy as well. Luckily, Rudd (2009) points that the Australian banks did not hold the “toxic” securities that relentlessly affected other major global economies and banks. The financial health of the Australian banks enabled the effectiveness of the fiscal and monetary response, principally by letting the easing in monetary policy to be delivered through to interest rates on loans to businesses and households. This was a stark contrast to the outcomes in other major economies. This was a major policy response to the financial crisis. Around the time that Lehman Brothers collapsed, the circumstances in foreign exchange market were mainly illiquid. This prompted the reserve bank of Australia to intervene in the market. The purpose of its intervention was to enhance liquidity. This was evident in the way the Australian dollar recovered. From March 2009, even as the financial crisis fears abated, the Australian dollar recovered substantially. This mirrored the virtual strength of the Australian economy as Puri, Rocholl & Steffen (2011) reinforce. The Australia government acted very quickly in the latter half of 2008 to lessen the impacts of the global financial crisis on the Australian economy. The government, through its chief policy maker RBA, guaranteed deposits of up to $1 billion that were held by deposit taking institutions. Cazes, Verick & Heuer (2010) point that this was to enable them to reassure their customers and depositors of the security of their funds as well as to ensure that banks access to capital was not affected. This was a major policy response to the global financial crisis; it ensured that the depositors with banks did not lose their money. The banks also have enough access to capital markets. As a result, the financial market in Australia continued as usual. The government was also determined to protect private spending by households. It introduced an initial economic stimulus package worth $10.4 billion in October 2008. The purpose of this stimulus package was to alleviate contraction in private spending. Moreover, the government further introduced another stimulus package worth $42 billion in February of 2009. Almost 30 percent of the spending was in form of cash hand out to the Australia households. To reinforce the stimulus package, the government directed $29.4 billion to add to infrastructure projects and also $1.5 billion to housing construction. This really improved private spending by households. Decisively, the government recognised the necessity to strengthen the Australian economy. It strengthened it by investing the $1.5 billion in the housing market; this was through the first home owners boost. This initiative was effective as it also responded to the twin challenges of record low housing affordability and subdued housing market; this assisted an estimated 150,000 first home buyers (Schularick & Taylor, 2009). As discussed above, the success and growth of the financial markets depends on the increase in income of households. When households become richer, they spend that money in the financial markets. The Australian policy makers understood this very well wand hence the government pumped the households with income and money handouts. As such, private spending did not slow down even during the GFC but increased as households had enough money to spend. This ensured that the financial markets remained operative just like before the GFC, this benefited the Australian economy to great extent (Obstfeld & Rogoff, 2009). It was able to withstand the global financial crisis. Another policy response by the reserve bank of Australia was to reduce the interest rates; this was meant to stimulate demand. This had direct effect in the market as the cash rate target dropped from 7 percent, in September of 2008, to 3.25 percent in the first quarter of 2009. This was a tremendous policy in the economy; it ensured that money continued to flow in the economy (Claessens et al., 2010). Again, this was a contrast to the other major economies where households did not want to spend thereby making money flow to deprive. The government also helped small businesses. It helped them to secure the jobs of over five million workers they employed in Australia as Puri, Rocholl & Steffen (2011) underline. Through 2008-2009, the government gave over 10,000 small businesses 12 months interest free deferrals on their goods and service tax obligations. In addition, it deferred their taxes on profits. However, this policy was not as effective as it was first thought; this is because there was increase in the number of small businesses declared bankrupt in 2008-2009. Another policy by the Australian government was to establish a financial stability forum (Reinhart & Rogoff, 2009). The Australian government forged for consensus for consistent international regulatory response to the financial crisis. It was concerned that extreme capitalism combined with unregulated greed would bring financial crisis in future if they are not combated. Chor & Manova (2012) adds that the government asserted that the financial institutions need to have clear and elaborate incentives for promoting responsible behaviour. This initiative was more of an international policy response to the GFC. It included regulatory reform (aimed at harmonizing existing standards and create news where gaps were identified). Essentially, the policy makers ensured that the Australian economy came through the global financial crisis in a solid shape; it was also able to avoid recession. A notable mention is the then Australian prime minister, Kevin Rudd, and his Treasurer, Wayne Swan who ensured that the government responded adequately to avert the GFC impacts and avoid economic recession. The prime minister deserves credit for effective economic management at a time when the Australian economy was faced with major financial crisis. In essence, the Australian makers were able to deal with the problems brought by global financial crisis in a very effective way. References Berkmen, P., Gelos, G., Rennhack, R., & Walsh, J, P, (2009). The global financial crisis: Explaining cross-country differences in the output impact (No. 9-280); International Monetary Fund. Brinkman, H. J., de Pee, S., Sanogo, I., Subran, L., & Bloem, M. W. (2010). High food prices and the global financial crisis have reduced access to nutritious food and worsened nutritional status and health: The Journal of nutrition, 140(1), 153S-161S. Campello, M, Graham, J, R, & Harvey, C, R, (2010). The real effects of financial constraints: Evidence from a financial crisis. Journal of Financial Economics, 97(3), 470-487. Cazes, S., Verick, S., & Heuer, C. (2010). Labour market policies in times of crisis; after the crisis: towards a sustainable growth model, 23. Chor, D, & Manova, K, (2012). Off the cliff and back; Credit conditions and international trade during the global financial crisis: Journal of International Economics, 87(1), 117-133. Claessens, S., Ayhan Kose, M., & Terrones, M. E. (2010). The global financial crisis: How similar? How different? How costly? Journal of Asian Economics, 21(3), 247-264. Claessens, S., Dell’Ariccia, G., Igan, D., & Laeven, L. (2010). Cross‐country experiences and policy implications from the global financial crisis: Economic Policy, 25(62), 267-293. Obstfeld, M, & Rogoff, K, S, (2009). Global imbalances and the financial crisis: products of common causes. London: Centre for Economic Policy Research. Puri, M., Rocholl, J., & Steffen, S. (2011). Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects.Journal of Financial Economics, 100(3), 556-578. Reinhart, C, M, & Rogoff, K, S, (2008). Is the 2007 US sub-prime financial crisis so different? 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