The Global Financial Crisis - Essay Example

Topic: General Questions Question The global financial crisis happened in the late 2000s when many major financial institutions collapsed or were being bought out. In addition, the world stocks were already falling. This triggered the national governments to formulate rescue packages to salvage their financial systems. The global financial crisis was triggered by an economic boom which was followed by a burst of a financial bubble that was global in scope. Although many technical explanations have been postulated, the collapse of the United States sub-prime mortgage market as well as the setback of the housing boom experienced together with the weakness in the global financial products are some of the reason advanced for the crisis (Mishkin,chp 4, pp 69, 2010).

Both Minksy’s and Minshik’s theories have developed under sound economic theory thus having strong support from the theory, but if considered what would result if the interest rate were zero? This is one of the weaknesses in both analyses; second with the two theories do not consider the money illusion concept thus assuming that the individual is not rational. Third, the debt, deficit management framework is not well designed so as to consider the effect of interest rates. This assumption is weak and unrealistic (Mishkin,chp 3, pp 52, 2010).

Question 2 The modern monetary theory was originally propagated by Knapp; this theory delineates the consequences of using fiat money in an economy. Fiat money is a currency created by the government. According to this theory, for money to be in circulation the government needs to spend, also in order to foster acceptance and private confidence in the currency issued by the government, the government imposes a tax obligation that corresponds to the government spending. In this case, the government will be able to macroeconomic parameters such as unemployment and inflation (Mishkin,chp11, pp 369, 2010).

A graph to illustrate the modern monetary theory, A change in either money supply or price level will increase the level of interest rates. Taylor's approach to inflation targeting: this refers to the monetary policy that many central banks follow, this policy stipulates how the central bank would stipulate the nominal interest rates so as to diverge the target inflation rates and the real GDP to the potential GDP. This rule takes into consideration the deviations that happened to the equilibrium level of unemployment and the inflation rate that is healthy for the economy (Mishkin,chp12, pp 408, 2010).

When there is underemployment this is advantageous to employers since they are able to obtain cheap labor as compared to a scenario of full employment therefore underemployment leads to a reduction of the cost of production. Short-term unemployment refers to unemployment that lasts less than a year and may be seasonal unemployment while long-term unemployment refers to a situation where unemployment last more than a period of one year(Mishkin,chp 13, pp 569, 2010). Question 3 In case the automatic stabilizing forces are present since Mishkin assumes that there is minimum government intervention.

Therefore, the IS-LM mechanism stabilizes (Mishkin,chp 14, pp 842, 2010). A graph showing the IS-LM framework, Interest rates LM IS Income There various ways of predicting downturn, for example through the use of the consumer price index; where the consumer price index rises then this implies that economic recession is looming. In addition stock index in a stock market can be used to predict a looming downturn (Mishkin,chp 14, pp 859, 2010) There is a need for government interventions so as to regulate the market and thus avoid the creation of a complex financial product that could lead to failure of the market(Mishkin,chp 15, pp 962, 2010). Stand-alone monetary policy is ineffective since the financial institutions might deliberately not follow the direction of the central bank.

In addition to this, the central bank cannot also force consumers to demand loans (Mishkin,chp11, pp 387, 2010)