The Global Crisis and Equity Market-Free-Samples for Students

Questions: 1.What was the main cause of the Global Financial Crisis (GFC) and why it has spread Internationally? Do you believe that it could have been prevented? 2.One of the tools Australia and many other Countries have used to fight the recession trends was to cut cash rates. The Reserve Bank of Australia has itself cut the cash rate from 6.75% in January 2008 to 2% in January 2016. Why do you believe central banks all over the world are using this tool to fight the recession in their Economies? 3.Why do you believe Australia cares so much about what is happening in China? What is the connection to the Australian Economy? Answers: 1.The Global Financial crisis that started from July 2007 had fully explored in 2008. The main driving factor for the financial crisis was credit crunch happened in housing market. During this time, the US investors lose their confidence. The US economy suffered with a liquidity crisis as resulted from reduced value of sub-prime mortgages. To counter the crisis US government injected a considerable amount of money in the financial sector. In September 2008, the crisis took a disastrous form as the stock market crashed and high volatility is observed globally (Treeck 2014). Not only investors but also the consumers lose their confidence and restrict their choices. The Global Financial Crisis originated in the US housing market. The homeowners in US had withdrawn their subprime loans because it becomes difficult for them to repay the mortgages. With declining price of houses, they find themselves in huge debt. There is large number of loan defaulters that put banks and financial institution in trouble. The valuation of land decreases as compared to the valuation when loans are given (Paulson 2013). Banks suffered from a liquidity crisis. Following the housing bubble burst lending or receiving loan became extremely difficult. The liquidity crisis in the economy is known as credit crunch. United State is one of largest economy in the world. It maintains economic relation with many other nations worldwide. The financial crisis in US spread internationally and countries went through a recessionary crisis. There were foreign banks that bought US collateralized debt. In times of financial crisis in part of these loans were transformed into collateral debt obligations. The financial institutions across the world participated in the debt transactions. For example, many European and British banks had exposed to the mortgage loans. With increasing loan defaulters in US theses banks suffered a huge money loss (Bekaert et al. 2014). The banking system in US is connected internationally. In the phase of losing money banks limit their lending to others. When banks restricted lending to each other there occurred a supply shortage of funds and firms and consumers and firms find it difficult to lend money from banks. The reduced supply of money was responsible for a declining aggreg ate demand (Helleiner 2014). As a result, countries those were not directly related to subprime mortgages in US housing market suffered from the crisis. US maintain a trade relation with many other countries. The recession in US caused a fall in their import demand. This affected the export demand of nations and exporting countries contracted with recession in US. The reduced volume of global trade makes the financial crisis a global phenomenon. The crisis in financial sector reduced the confidence of firms and consumers resulting in a global crisis. The global stock market was severely affected by the financial crisis (zmen and Ya?ar 2016). Declining share price means lower wealth and reduced confidence leads to lower growth. The Global Financial Crisis in 2008 could have been prevented if Federal Reserve did not ignore the early signs and take active steps at the beginning of the crisis. The lending indicators first signaled trouble in November 2006. Then the commerce department reported a drop in home permits by 28 percent. However, then Fed did not believe that housing price could fall. Fed then remained optimistic and believed on the strength of domestic economy to counter housing price slump (Godlewski 2014). If government intervenes at the early stage then U.S. and rest of world could be saved from the crisis. 2.Bank rate is the interest rate that central bank charges to the commercial bank on borrowed fund. The Bank rate in Australia and New Zealand is knows as official cash rate. This is an effective tool used by the central bank to control money supply in the economy. Banks and financial institution are made for settling inter-bank transfer of funds and the transaction rate for the cash are determined through buying and selling of bonds and government securities through money market operation (Mian and Sufi 2015). Recession is defined as a declining phase of economy characterized with a significant downturn in all economic activity. During recession, the economic suffers from a decline in its Gross domestic Product, slowdown of general price level or inflation, low wages of workers and rise in the unemployment rate. When the declining phase continued for at least six months, it is termed as recession. Persistent recession for one year or more put the economy in steady depression (Cynamon and Fazzari 2015). Therefore, it is important for nations to combat recession before taking the forms of depression. The policy makers to revive the economy use expansionary fiscal and monetary policy. The expansionary monetary policy aims at increasing the money supply. A reduction in the Bank rate or Cash rate is the most effective tool to achieve this goal. When central bank reduces the bank rate then it becomes easier for commercial banks to borrow money. With ease of borrowing, the supply of loan able fund increases. The increased supply of funds reduces the interest rate that investors have to pay for borrowed money from the commercial banks (Juselius et al. 2016). Therefore, a decrease in cash rate encourages investors to borrow more funds. The productive investment increases output and expands demand. There is another channel for interest rate to affect the aggregate demand. The lower interest rate discourages household for saving and increase their consumption spending. This increases aggregate output. This can be evaluated using the framework IS-LM. Figure 1: Effect of a reduction in cash rate (Source: as created by Author) The LM curve reflects the effect the monetary policy. When the central bank reduces cash rate, the available money supply increases and it causes shift the LM curve rightward from LM to LM1. Accordingly, interest rate in the economy reduces from r* to r1and output increases from Y* to Y1. This is how a reduction in the cash rate is supposed to increase the aggregate demand and output. In order to achieve this goal and combat recession central all over the world uses the tool of cash rate to fight recession in their economies. The Global Financial crisis originated in United State affect Australia and other major economies worldwide. These countries suffer a recession and government there gave attention to counteract economic downturn with unveiling fiscal and stimulatory packages. The Reserve Bank of Australia Quickly responds to the recessionary crisis by cutting cash rates. Overnight there was a cut in the official rate by 425 basis point and fall to the emergency level of 3% (Bhutta and Keys 2016). By lowering the cash rate Australia escaped from the recession during Global Financial Crisis that affects other OECD nations. With reduced cash rate, an improvement in the trends of household demand is observed. This is associated with a strong employment growth. For the last few years, RBA maintains the cash rate at the recorded low level. However, the monetary policy stimulus affect the economy less than the Central Bank actually expects. The RBA estimated cash rate to be at 3 percent, which is equal to i ts inflation target of 2.5 percent plus real rate of 1 percent. However, since 2014 the consumer price inflation in Australia has failed to reach to targeted level (Green 2016). Following great recession many advanced nations adapted an expansionary monetary policy. It was Central bank of Denmark that first implemented a negative interest rate. The central banks of several European nations and bank of Japan followed the same. The low or negative interest rate initially helped the economies to counter recession (Illes, Lombardi and Mizen 2015). However, it comes along with a distortion in the financial market and raise the risk of financial instability if funds are not used for productive investment 3.It is long sine Australia shares a good economic relation with China. Chinas growth manifests urbanization, manufacturing growth and infrastructure investment. This generates demand for building materials, manufacturing raw materials and energy demand transport and electricity. Australia was in well position to meet Chinas growing demand and provide a ready platform the manufactured goods produced in China. Since then an economic relation of mutual dependence builds and develop gradually. China today is considered Australias one of the largest trading partners making significant contribution both for export and import. Australia is in position of sixth largest trade partners of China. Almost twenty five percent of manufactured import of Australia imports from China and export 13% of thermal coal to China. The dependency of Australia is not limited to its trading relation but also in terms of investment. China is a major source of Australias foreign investment. China is the third la rgest investors of Australia with making 3% of its total investment through channel of direct foreign investment. China is keen in investing infrastructure projects in Australia (Sheng 2016). The businesses in Australia are affected from economic fluctuation in China. During Chinas economic boom, the business gain significantly. However, recently China has shifted its growth policy towards a more consumer-oriented economy. The reliance on consumerism makes the economic growth in China slower. Many Australias business is expected to derive profit from supplying their product to China. They are likely to suffer a loss from slowdown of Chinas economy. Chinas economy has severe impact on global economies but Australia is more exposed to growth decline in China than others are. A major share of Australias export (Above 28 percent) goes to China. The expanded export market and Chinas investment to Australia make the economy heavily dependent on China. The economic strength of China is one of the important determinant factors of Australias economic growth (aph.gov.au 2017). There are number of ways through which impact of Chinas economy on Australia can be evaluated. The slowing economy of China means a reduction of bilateral trade volume between China and Australia. Australia mostly exports Coal, Copper, and Gold, Cotton and Nickel ores and minerals. In the minerals category, Iron Ore dominates. However, Australia also export agricultural product to China. With a declining growth in China, the export demand from Australia declines. The sudden fall in the trade volume causes an oversupply of goods in Australia. From the supply demand framework it is evident that an excess supply of goods lower prices in the market. This is what Australia expects and cares for Chinas economic situation before taking economic decision. When domestic economy slows, then many investors in China drive out their funds from Australia. Chinas investors mostly invest in infrastructure projects in Australia. If the funds are withdrawn then Australian economy will hugely suffer. The tourism industry is likely to be affected when tourists from China reduce their spending. During Global Financial Crisis, China helps Australia a lot and prevents the economy from sinking. Chinas demand of minerals provides support to Australia and maintains economic stability of Australia (www.smh.com.au 2017). However, China protects Australia in times of Global Financial crisis; it is believed that Chinas money raises the property price in eastern region. From 2000 to 2014, the average annual growth rate in China is recorded as 9.75%. The growth rate slows down from beginning of the present decade. In 2011 growth rate was 9.5% followed by a growth rate of 7.8 percent in 2012, 7.7 in the next year and 6.9% in 2015. The slow down resulted from the shifted attention from investment led growth and dependence on consumption based growth. The growth rate is predicted to be even slower in the next years. The poor condition of infrastructure and industries in China have affected many Asian economies including Australia. The declining growth rate in China, outflow of Capital and action of Peoples Bank of China for hedging fund together contribute to a contraction of Chinas economy (abc.net.au 2017). This creates uncertainty for the Australian economy. The financial crisis in China has spillover effects on other region and negatively affects commodity prices of any important goods in Australia. Australia mostly exports mineral resources such as iron ore, gold, copper, nickel and other resources. As the Chinas economy contracted the demand for mineral resources from China also shrinks. 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