Answer 1:Mishkin believes that financial crises are caused by the imperfect information in the market. It is a result of this imperfect information that funds channeling to the right sectors is hindered and as a result these sectors suffer causing them fall and bring about trickle down changes to the economy as a whole. This imperfect information is caused by increased in interest rates which discourage investors to invest their money in the certain sector. They might think that interest rates are too high to cover the cost of investment. On the other hand, what they might not know is that return will cover the cost of investment and will earn them a decent return.
This is because they do not have the right information or there is imperfect information that they may be discouraged to invest in a certain. Increases in uncertainty also create imperfect information at people might become too reserved and may not be able to distinguish bad investment from good investment. Problems in banking sector and Asset Market Effects on the Balance Sheets are yet other causes of imperfect information.
The problems in banking sector signals investors that something is wrong and they fly away their investment to other countries causing liquidity problems and financial crises occur in a country. Minsky, on the other hand, believes that financial crisis occur due to capitalist approach in which the economies are run. He believed that fragility in the financial system is the result of privately owned businesses and resources in an economy. He also classified that firms use hedge, speculative and ponzi finance to run their operations. Minsky stated that in the first stage, banks were giving hedge finance to earn return on investment.
However, even after this there was excess liquidity and banks started giving speculated finance in which they did not ask for collateral on loans and income certificate was enough to get a loan. However, the financial crisis started when the banks started using Ponzi finance. Here, they did not ask for either collateral or income certificate but gave loans on credit score. These loans are also known as subprime loans. The best example of this type of lending is subprime mortgages.
He believed that banks were unable to recover these mortgages and due to declining house prices, they were not even able to recover their investment and as a result financial crisis started. In a nutshell, he believed that Ponzi finance was the result of these crises. Answer 2:Mishkin believed that Liquidity Preference is made up of people wanting to invest their money into profitable venture. This way they can increase their wealth and earn return on their investments. Any dollar that they invest in any venture should cover their initial cost of investment and should give decent amount of return on investment.
On the other hand, Keynesian Liquidity preference is not just made up of money needed to invest, but also for two other motives. Theses motives are called precautionary motive and transaction motives. The transaction motive states that demand for money comes for people’s necessity make daily purchases for food, clothing etc. The precautionary motive states that demand for money comes from people wanting to hold money to meet unexpected events such as visit to a doctor etc.
This shows that Keynesian liquidity preference is broader than Mishkin’s Liquidity preference. In other words, Mishkin’s liquidity preferences is dependent more on the market information than anything, whereas as Keynesian Liquidity preference also takes into account current and future needs.