Financial Institutions Affect - Assignment Example

?Assignment 2 Do the Financial s Affect the Economic Growth of A Region or Not Recessions occur in the world from time to time. Starting from the great depression of the 1920’s to the recent 21st century economic slowdown, financial institutions like banking sector are linked directly with these economic mishaps. Do financial institutions like banks really drive the economic growth and downturn of a country is a million dollar question. Several experts have analyzed the same. Gurley's theory states money always remains stable, but the increase and decrease in its flow determine the various changes in business. This theory was the base of Lucas's neutrality-of-money paper. The neoclassical tradition emphasizes that the demand for a product in the market and the quantity supplied determine the employment and labour cost. Milton Friedman had also constructed mechanisms with a similar view. The minor misconceptions in the Friedman's theory were corrected by Lucas by establishing a perfect balance between the "long-run" and the "short-run" non-neutrality essential for money based business cycles. The basis of both their constructs is that money is "exogenous”. They simply mean the central authority handling it can easily determine the constant supply of money. We all know the institution of banking is the above mentioned authority in the modern economy. By analysing the banking sector further, with the Lucas's theory, we will be able to determine whether the modern day money-creating systems lean towards neutrality or non-neutrality of money. Both the scholars did not consider the relation of bank assets and money as well as the borrower’s use of these assets. The banking sectors operate actively by investing on assets and lending the profits earned to others. We all know how influential the banking sector innovations can be on the core business management strategies. The best example is the 1985 game of mergers and acquisitions. Schumpeter said, innovation is the base of market power which will provide great temporary powerful positions, but this monopoly power will erode soon. It is true. We see the rise and fall of several banks, boosting the economy of a region considerably and disappearing like a bubble in a short time. The reason for this is, several banks spring up following one successful model, without any proper goal. They are just “lured imitators” according to Schumpeter and they are the main factors causing the short term monopoly in the market. Certain scholars like Hicks argue these quick profits created by the short term monopolies are quite important to keep the market active, inspired and running. Schumpeter’s innovation concept doesn’t fit the banking sector alone. In fact, they fit all technological and developing sectors. Innovations in finance will increase investments on the other sub sectors, creating a more technically sophisticated world. The role of speculators or middle men who act as a bridge between the financial sectors and the industries requiring investment also plays an important role in determining the actions of the financial institutions. Keynes’s words stating speculators are not mere bubbles, but they are capable of making a whole institution become bubble in the speculation whirlpool is worth consideration. According to Schumpeter strong financial institutions are the base of a countries economic growth, as it is innovative and kindles growth. But, Lucas, Levine and many other authors just considered the role of such organizations like banking have been “badly over-stressed” in relations to economical growth of a country. There are some key questions to answer 1. How do the financial institutions emerge and why? 2. Under what circumstances do the financial institutions develop rapidly? 3. Are they really necessary and do they actually affect the money flow of a region or country? Any innovative organization wants more money to grow. They are the drivers behind these financial institutions. The capital gain of the industries helps in setting up such firms. The common people are given a chance to invest money on the companies, who use it to improve their assets. The investors gain from the interests and dividends given to their money. The price of each firm is determined based on its assets and operations in the financial market. The entrepreneurial organizations also use the financial institutions like banks to create constant cash flow for further growth, based on their price value in the market. The The financial institutions like banks thrive in circumstances where the industries are in constant need of cash flow. The banking sector arranges this cash flow in the form of debts to the major companies. In several parts of the world, even a small decline in the constant cash flow from banks will affect the internal budget of huge companies in innumerable ways. They will be forced to borrow money from external sources, which will lead to massive losses for both the company and the banks which are expecting interests on the debt given to them. On the other hand, these financial institutions are responsible for transforming the capital gain of the companies into market power and luring in more investments from the public to their growth. Financial institutions are greatly essential for an even operation of a society. They have certain functions of their own, which emphasize their role in the society, strengthening their importance to a widespread level. They are essential for good collaboration between the industrial sectors, market and the public. Their main function is the asset transformation. Public’s savings are invested in growth sector industries and the profit asset is distributed among the common people. These markets actually determine the flow of money from one social group to another, influencing the wages and prices according to the Gurly’s theory. The speculators or financial inter-mediatory people have significant role to play in this process. Exchanging the assets on their own personal accounts along with the public is their important role. They provide valuable advice to the market participants and help in managing their portfolio. Considering these roles, they are definitely important for a nation’s growth and they do substantially influence or affect the growth and decline of a country or a region’s economy in several ways. References Levine, R. (1997), ‘Financial Development and Economic Growth’, Journal of Economic Literature, 688 – 726. Read More