Notesale: Turn your study into money

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HULT International Business School
Economy Theory & Application (ECN102) - A
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Bubbles & Financial Crashes
Explain why the crash of 2008 happened, making sure you analyse the contribution of the following: House prices, debt
backed securities (CDOs), Herding, the nature of Bubbles, Leverage and Deregulation
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This essay will analyse how these factors led to this
crisis
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This discouraged investors whose return was too low
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There was an abundance of ​cheap credit
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Deregulation of the financial sector is also one of the primary causes that led to the financial crash of 2008​
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This law was initially intended to prevent
commercial banks from speculating in the security markets and avoid crisis like the one of ​1929​
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In fact, commercial banks created CDO’s (​Collateralized Debt Obligations​,
package of debts), ​mortgage backed securities that were then sold to investment banks that would trade them as
a financial product
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(II) The ones (​investors, pension funds, hedge fund or Lehman brothers​) owning and trading CDO’s did not care
much about the ​risk of default since they were insured by ​CDS ​(credit default swaps) sold by ​American
International Group (AIG)​
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Banks lent cheap adjustable rate loans to poor Americans who were a higher risks, meaning that banks could
charge them higher interests to increase their profit
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People expected house prices to go up,
which encouraged speculative behaviour
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This default crisis decreased the value of CDO’s and let to the bankruptcy ​of their
holders like the Lehman Brothers bank​
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Debt crisis ​was exploding everywhere in the financial system
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Conclusion:
The 2008 crash was permitted through ​deregulation​
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Investors who bought them did not care much about their risks since they were insured by ​CDS and good
ranking from rating agencies
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HULT International Business School
Economy Theory & Application (ECN102) - A
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Bubbles - Deflation - Monetary Policy
After the 2008 crash governments enacted extreme and unconventional monetary policy measures
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Introduction:
After the financial crash of 2008, the economy fell apart, it faced stagnation, high unemployment and a deep
recession
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Instead,
central banks used unconventional monetary policies to stimulate the economy
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(I) ​Quantitative easing​​ is a measure used by central banks to increase the money supply by buying long term
bonds or securities with newly printed money to other banks and financial institutions
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Quantitative easing pushes down the yield curve which lowers interest rates for investors whose
investments will stimulate the asset markets and the economy
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Central banks buy
non-governmental long term bonds and securities ( such as mortgage backed securities and treasury bonds) from
private financial companies to change the quality of the securities it holds, with more risky assets
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(III) ​Operation twist​ is a tool of the credit easing
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This method differs from qualitative easing because the
banks do not buy private securities
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In fact, buying long term bonds help the
central banks push interests up and yields down
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This tool was used because quantitative easing was increasing the quantity of money on the
market, increasing inflation risks
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This monetary process involves charging
commercial banks for money deposits at the federal reserve
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This method has been used by the Banks of Japan to cope with deflation and
increase the level of consumption and investment
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Wright
Final Exam Essay Answers Type

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Those conditions include the long recession and stagnation since the 2008 crash, but also high government debt (for some
nations)
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What are the policies supported by each side and what are their arguments in favour of each? Also, explain what
view Keynes would have supported and why
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Economists and politicians have been arguing on which
macroeconomic policy best fits to solve issues like the long recession, stagnation and high government debts
following the 2008 crash
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This is done without considering the
effects of the economic cycle
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These involves cutting real government spending and increasing taxes
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The UK government has also cut
local authorities and defence spending and introduced welfare caps, limited social security benefits ( like
pensions, and job seekers allowance)
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Quantitative easing
has also been used to make debt interest rates fall
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In using fiscal austerity in countries like UK the right policy ? Some will favour this for the
following reasons
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At the first, it reduces debt in the long run which helps keep UK taxes lower for future generations
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Promotes the growth of private sector and shrinks the size of the state intervention through more
resources being available and the falling of private sectors debts and interests rates
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There is also a huge opportunity cost on debt interests
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(II) ​Nevertheless, austerity has downsides
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Bonds yields remain to low in a time to invest more in infrastructure, schools and hospitals, sectors that can lead
to economic development and social benefits
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Plus, economic growth is needed to refund the debt but fiscal austerity hamper the
growth
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They are in favour of functional finance and
countercyclical fiscal policies
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Governments should intervene to diminish the high fluctuations
of the economy and make it more stable
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These involve cutting taxes and increase government spending which will lead to deficits
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Expansionary monetary
policies such as Quantitative easing used in the US for example, has led to a more indebted USA and larger budget
deficits
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They consider sounds
finance as the best solution to implement austerity
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They advocate procyclical fiscal policies , such as the automatic stabilisers that would
counterbalance the fluctuations of the economic cycle without government intervention
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In a period of recession, the classicists favour contractionary fiscal
policies,meaning government spending cuts and taxes raises
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Ricardian Equivalence hypothesis supports the idea that in certain
conditions, the government should run a deficit and that deficits did not impact the levels of income in the
economy
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He thought that individuals are far-sighted and therefore increase their savings for future tax
increases
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According to this
theorem, there is then no need to cut the taxes
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Classical
economists are opposed to government intervention and prefer instead let the market regulate itself and avoid
stimulus like the interests crowding out
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This happens when the government
increases interests rates in the economy to make the bonds it issues more attractive and eventually finance its
deficits
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But the Keynesians fear that procyclical policies
may plunge the economy into a depression during recession period and hyperinflation during the expansion
period
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Conclusion:
To put it in a nutshell, stimulus and austerity present both advantages and inconvenients
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This is why modern
economists prefer mixing procyclical and countercyclical policies
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When there is recession, the government should run an
expansionary policy and during expansion, a contractionary fiscal policy
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