World Financial Crisis: Causes, Effects, and Solutions - Example

World Financial Crisis Name Institution Date Table of Contents Table of Contents 2 Introduction 3 Background of the world financial crisis 3 Overview 3 History of Financial crisis 3 Cause of World financial crisis 4 A brief chronology 4 Primary effects 4 Effects of financial crisis 6 Short term effects 6 Long term effects 6 Solutions 7 Used /implemented 7 Proposed 8 Conclusion 8 References 9 Introduction Financial crisis are things that occur often commonly, therefore making them a common phenomenon. In fact, the world has suffered and has been hit and affected by many crisis, therefore making the current one not probably the last. However, the World Financial Crisis is termed as the most pronounced and severe as compared to the depression that was suffered in 1930 because many factors, ranging from macro-economic to market factors contributed to it There has been a lot of complexity in market operations therefore proving difficult to manage and regulate market operations. Some of the effects have been classified as short term, where as others have been classified as long term, reason being others are viewed to stabilize after a while whereas others will stabilize after a long time. Therefore, this report seeks to find the causes of the global economic crisis, the impacts and possible solutions Background of the world financial crisis Overview The global financial crisis of the year 2008 was the most severe and whose effects can be felt even now, amounting to reduced levels of economic activities and consequent decline in economic growth (Wolf, 2014) History of Financial crisis On September 11, 2008, the Lehman Brothers made a decision to file for chapter 11, hence leading to a financial crisis (Norgren, 2010). Consequently, this led to one of the worst global financial performance. Ideally, the crisis is said to have developed from The American market, commonly known as the housing market. Prices in the housing market dropped by more than 31% in the year 2006 (Norgren, 2010). Consequently, the level of household debt increased at a big rate and lending made to low income earners increased, as evident in Fig 1 In the year 2006, house prices declined tremendously as a result of decreased levels of construction activities. However, with an attempt to respond to the increasing decrease in house prices, house owners increased their own savings, negatively impacting on the general growth of the economy (Sivakumar & Krishnaswami, 2011)Additionally, financial institutions and lenders reduced their lending because there was too much borrowing as a result of reduced rates and financial institutions were concerned about their money and possibility of repayment Fig 1: Showing levels of house debt. source: (Norgren, 2010). Cause of World financial crisis A brief chronology The global financial crisis is known to have been propelled by a number of factors, classified as either macro-economic causes and financial market causes Primary effects 1. Macroeconomic causes a. Growing imbalances For long, many nations had been known to operate on huge current account deficits (Norgren, 2010). In contrast however, a number of oil producing and exporting countries and other well developed nations such as China have been known to operate on huge current account surpluses, as evident in Fig 2. Consequently, the account balances were seemingly invested in most developed countries. This increased levels of demand consequently led to high prices accompanied by reduced low levels of return on government securities. Fig 4: Showing current account surpluses. source: (Norgren, 2010). b. Higher levels of risk taking Ideally, any increase in debt demand level must be proportionately matched with increased levels of bank deposits (Ellis, 2011). However, this was not the case during the times of world financial crisis, forcing banks to solicit for funds from a different source, consequently making them wholly dependent on outside funding. As a result of this scenario, many financial institutions developed high levels of financial and liquidity risk. Because of low levels of interest rates coupled with low yield levels from government bond, investors were therefore forced to take higher levels of risk in order to be assured of higher return levels as evident in Fig 3. Fig 3: Showing high levels of risk taking, source: (Norgren, 2010). 2. Financial market causes The consequence of deregulating financial markets and institutions in the 1970’s led to the development of complex financial institutions. Similarly, innovations in the financial markets led to developed levels of complexity in managing financial relationships between financial institutions (Sivakumar & Krishnaswami, 2011). For example, the emergence of over the counter derivatives (OTC) as a form of financial innovation has led to more complex operations in the financial market Effects of financial crisis Short term effects A number of short term effects of the world financial crisis include reduced levels of revenue from the tourism sector, reduced level of confidence people place on financial institutions, and sharp changes in interest rates. These changes are termed as short term because economists argue that the effects will fade and stability will be achieved after a short time (Institute, 2016). Long term effects i. Achievement in terms of education As a result of increased levels of unemployment, there will be reduced levels of educational achievement because families won’t be in a position to provide basic educational needs for their children (Gezici, 2010). Additionally, there will be high cases of children abandoning college education because of a view that there is no employment (Institute, 2016) ii. Lost opportunities As a result of the levels of unemployment observed after the crisis, the lost income, means that majority of people won’t be in a position to fed their families therefore leading to increased poverty levels, which in the long run impacts on the economy, especially in the developing countries (Institute, 2016). Similarly, output in various parts of the world will be affected as indicated in fig 4 Fig 4: Showing levels of unemployment between two countries: source: (Norgren, 2010). iii. Reduced entrepreneurial activities and business establishments Entrepreneurs are often regarded to be the center of technological progress and advancement. However, because of the economic crisis, entrepreneurial activities will reduce in the long run because of reduced credit levels. For instance, in the year 2008, more than 44,000 businesses were declared bankrupt, the figure being higher compared to the number of businesses that were declared bankrupt in the year 2007, which was around 28,000 (Institute, 2016). Solutions As a result of the effects of the global financial crisis, there have been attempts to figure out how the challenges can be overcome both in the short and long run. Therefore, some solutions have already been implemented, whereas others have been proposed and yet to be implemented. Used /implemented As a move to respond to the short term implication of the crisis, governments in both the developed and developing economies have implemented measures aimed at strengthening the financial system. Additionally, governments, in both developed and developing nations have implemented expansive monetary policies in order to contain the increasing interest rates, mostly charged by central banks. Another move that has been implemented to contain the crisis is to solicit for funds from the International Monetary Fund (IMF) (Edey, 2009). In fact, number of recent financial crises which have occurred in the developing countries is as a result of either reduced or lack of international credit. The IMF in such cases has responded by making an injection of extra funds. With an aim of promoting confidence in financial institutions, interest rates have been lowered, making borrowing affordable. Another move that has been implemented in order to curb the financial crisis effect is to solicit aid from the Federal Reserve in order to improve on liquidity (Ellis, 2011). Similarly, international trade has been encouraged and nurtured by putting in place measures to promote trade and eliminates protectionism Proposed A number of proposals have been made to solve the after effects of financial crisis. Firstly, there has been a proposal that the IMF and other International Financial Institutions (IFIs) inject extra funds to meet the balance of payment requirements and to enable fast truck the recovery process (Edey, 2009). Secondly, to prevent another crisis from occurring, a proposal has been made to form a board whose major role is to spot risk and develop regulations relating to the management of credit agencies. Thirdly, another move that has been proposed to solve the crisis is to make a crackdown on all possible tax havens and to develop stringent measures to be taken against the non-compliant. Lastly, there is a proposal which touches on governance, functioning and mandate of the International Financial Institutions (IFIs). The proposal is that structures to improve on IFI’s accountability, transparency and representation should be developed. Therefore, all these are proposals to solve the after effects of global financial crisis Conclusion In conclusion, Financial crises have been there, they are there and the fact that they happen now doesn’t rule out the possibility of them not happening again the in the future. However, though the forms in which they may happen varies from one crisis to another, their characteristics are common. Similarly, financial crises have detrimental effects on economic development, both in the short and long runs. Therefore, to tone down the after effects of financial crisis, it is important that reasonable structures are proposed and implemented by relevant parties. It is evident therefore from this report that crises do occur and they have severe effects on the economy, both in the short and long runs. Similarly, there effects can be tackled by proper implementation of secure financial structures to boost economic growth. References Edey, M. (2009). The global financial crisis and its Effects*. Economic Papers: A journal of applied economics and policy, 28(3), 186–195. Ellis, V. (2011). Greed is (not) good. Work Employment & Society, 25(1), 163–169. Institute, E. P. (2016). Economic scarring: The long-term impacts of the recession. Retrieved August 19, 2016, from http://www.epi.org/publication/bp243/ Sivakumar, N., & Krishnaswami, S. R. (2011). Global financial crisis: Dharmic transgressions and solutions. International Journal of Social Economics, 39(1/2), 39–54. Gezici, A. (2010). Distributional consequences of financial crises: Evidence from recent crises. Review of Radical Political Economics, 42(3), 373–380. Norgren, C. (2010). The causes of the global financial crisis and their implications for supreme audit institutions. Retrieved from http://www.intosai.org/uploads/gaohq4709242v1finalsubgroup1paper.pdf Wolf, M. (2014). How the financial crisis changed our world. Economic Affairs, 34(3), 286–303. Read More