essay plans Flashcards
1
Q
Why was the emergence of modern central banking slow?
A
- Early confusion the
role of CB - no clear understanding of their broader role - Distrust of power - wary of giving too much control to a single institution
- Limited
understanding of
Economic Cycles
and FC - economic theories less developed in 18/19th century, so little push to create institutions that could handle financial crises or downturns - Impact of FC and
Interwar Period - highlighted need for CBs as LOLR, helped govs realise CBs needed more power to manage crises - Influence of GS - MP restricted under GS as they need to maintain a fixed ER - this reduced role of CB
2
Q
What role did monetary policy play in the Great Depression and other crises?
A
- Monetary Policy as a trigger in GD
o tight monetary policy in late 1920s - Fed increased IR to stop speculation - slowed economy down and contributed to GD
o failure to act as a lender of last resort - Fed didn’t provide enough support to failing banks - made banking crisis worse - Deflationary Spiral Due to Monetary
Contraction
o GS constraints - stopped CB from printing more money to combat GD
o debt deflation - prices fell = increased real value of debt = harder to pay loans back - Role of monetary policy in other fc
o Post WW2 and Bretton Woods era - Fixed ER set post WW2 but led to crisis in 70s - CB couldn’t balance ER stability with domestic needs - led to collapse of BW - Monetary Policy in 2008 FC
o Loose mon pol before crisis - CB kept IR low - cheap credit = risky lending = housing bubble
o response to crisis - CB lowered IR and established QE to stabilise markets - recovery but raised asset prices - Eurozone crisis
o ECB limited response - slow due to focus on controlling inflation
o unconventional policy tools - LTROs and OMT
3
Q
To what extend did WW1 contribute or cause the Great Depression?
A
- War-Induced Economic Instability
o debt accumulation due to financing war
o heavy reparations - Germany - pay massive reparations through borrowing and defaults, and hyperinflation = created instability - Weakening of GS
o Rise of US as creditor after WW1 - europeans owed a lot to the US so strained Euro economies when US started recalling loans in 20s
o Trade imbalances and protectionism - to shield their economies after WW1 distrupted global trade - worsened situation - Post-war Economic policies and financial fragility
o Dependence on US capital and loans - Europe depended on US capital to stabilise its finances - US tightening mon pol made credit less available so financial instability
o fragile banking systems - due to war debts and inflation - Psychological and Social Effects of the War -
o loss of confidence and social upheaval - weakened consumer confidence and disrupted labour markets
o Political Radicalism and Instability - due to economic hardship, and worsened Great Depression
4
Q
How did the gold standard and monetary policy impact the Great Depression?
A
- The GS and Economic Rigidity
o Fixed Exchange Rates - tied to gold so couldn’t adjust ER in downturns
o Deflationary Pressures - CB raised IR to keep gold reserves = harder to borrow = slowed economy = prices and wages fall, also made debt more expensive = bank failures - GS constraints on mon pol -
o Lack of monetary flexibility - prevented CB from lowering IR or increasing MS to boost economy
o Global transmission of economic downturns - countries interconnected under GS - US increase IR to attract gold = gold shortages in other countries - Impact of mon pol mistakes in the US -
o Tightening of mon pol in late 1920s - US raised IR = slowed ER and harder to borrow
o Failure to act as lender of last resort - bank failure in 30s = Fed Res didn’t provide enough liquidity = banking crisis, collapse in MS, and worse deflation - Role of GS in Global Economic Contraction -
o Spread of Deflation - GS cause economic downturns in one country to spread
o Currency devaluations - those that left GS earlier allowed them to devalue their currency, adopt looser policies, and recover faster from GD - Debt Deflation and GS -
o Debt deflation dynamics - deflation made debts harder to pay
o Constraint on recovery - countries still on GS couldn’t implement policies to reduce debt burdens - Shift away from GS and recovery - countries in early 30s abandoned GS - allowed them to devlaue their currencies, boost exports, and use more flexible mon pol - quicker recovery
5
Q
How and why did various crises (e.g. US subprime, Eurozone) escalate from national to global levels?
A
- Financial Interconnectivity and Globalised Markets -
o Global financial ties - through investments, credit agreements, and asset trading
o Contagion through financial instruments - securities in US housing market lost value due to collapse - caused global losses
o Globalised banking sector - banks stopped lending to each other if one bank faced trouble - Transmission through interbank lending and credit markets -
o Global Credit Markets - CB had to step in to provide liquidity when interbank lending didn’t
o Liquidity shortages - banks relied on interbank lending for liquidity - stopped due to uncertainty - Institutional and Policy-Driven connections -
o CB and currency unions - Eurozone - Greece couldn’t devalue their currency due to shared euro - harder to reduce debt or improve competitiveness
o Shared institutions and bailouts - Euro crisis required help from ECB and IMF - caused economic tensions - Global Trade and Investment Channels -
o Interdependence in trade - if one country’s economy slowed, it reduced demand for imports = affected global exporters
o Impact on emerging markets - they faced capital flight, causing currencies to drop and inflation to rise - Psychological and Perceptual Factors (Contagion) -
o Panic and Loss of Confidence - causes investors to pull out money everywhere
o Perception of systemic risk - fear one institution’s collapse could trigger domino effect - restricting their global lending - Delayed or insufficient policy response -
o Inadequate early intervention - GFC - early responses too slow and uncoordinated - worsened crisis
o Austerity measures in Eurozone - deepened their recessions and slowed global recovery
6
Q
How does contagion occur in financial crises, with specific examples?
A
- Channels of contagion
o Direct financial linkages - distress in one market can impact others with similar exposures
o Investor behaviour and panic - loss of confidence can lead to capital withdrawls
o Trade linkages and economic interdependence - reduced demands for exports can affect global supply chains
o Policy transmission - countries with coordinated monetary policies affected with one country’s crisis - Examples of financial contagion
o The 1997 Asian Financial Crisis
o 2008 US Subprime Mortgage Crisis
o Eurozone Sovereign Debt Crisis (2009 – 2015) - Factors that exacerbate contagion
o Herding behaviour and speculation - investors panic cause widespread sell-off
o Inadequate policy responses - delays in intervention can lead to prolonged uncertainty
o Financial deregulation and complex products - financial innovations can spread risk globally, increase exposure to underlying assets, and exacerbate contagion
7
Q
Was the Eurozone crisis primarily a government debt, banking, or currency crisis?
A
- Government debt crisis (primary
element) -
o Sovereign Debt Overhang - unsustainable public debt so raised fears of default
o Deficits and Austerity - exposed large budget deficits and debts - caused loss of confidence
o Bailouts and Conditionality - austerity measures from IMF worsened economic conditions - Banking crisis (secondary element) -
o Bank exposure to sovereign debt - value of bonds in European banks dropped, and raised fears of a banking crisis
o Liquidity Crisis - due to investors pulling their funds
o Bank Failures and Rescues - require bailouts - Currency crisis (secondary element) -
o Inability to devalue - due to sharing the euro
o Confidence in Euro - concerns created volatility
o ECB Interventions - slow as a LOLR so made crisis worse
8
Q
Should there be an international lender of last resort?
A
- Role of lender of last resort
o Domestic - CBs
o International - no institution to do so - Potential benefits of an international
LOLR -
o Stabilisation of Global Markets - inject liquidity into economies, preventing regional issues from spreading
o Avoidance of Currency Crisis - help countries defend their currencies from speculative attacks
o Reduced Dependence on National LOLRs - quicker and more consistent help from global LOLR - Challenges and Criticisms -
o Moral hazard - encourage risky behaviour as countries assume they’ll just be bailed out
o Governance and Sovereignty Issues - countries might resist giving up control on economic policy
o Funding and Resource Limitations - how funds are raised
o Unequal Influence and Fairness Concerns - smaller countries may worry that major economic powers would dominate decision-making - Current Alternatives and Their Limitations -
o IMF - limited resources and conditional loans
o Currency Swap Arrangements - swap lines often limited to certain countries
o Regional Financial Safety Nets - lack global reach and resources needed - Feasibility and Recommendations -
o Strengthen the IMF as LOLR - by increasing resources and reducing reliance on austerity measures
o Establish Clearer Swap Arrangements - could improve emergency liquidity support without need for new global institution
o Develop a Global Reserve Fund - enabled faster crisis responses
9
Q
What are the merits and differences of the IMF and US Federal Reserve as lender of last resort?
A
- Roles as lenders of last resort IMF -
o Global mandate - liquidity support
o Conditional assistance - loans come with structural reforms
o Resource pool - funded by member countries
o Focus on emerging markets & developing economies - primary role to stabilise these economies - Roles as lenders of last resort Fed Res - o Domestic focus w/ global spillovers - via dollar swap lines
o Unilateral decisions - prioritised US interests but impact global markets
o Real-time liquidity - provided almost instantly - Merits of the IMF as a LOLR -
o Global reach
o Crisis prevention - surveillance, advice, and technical assistance
o Pooling of resources - reduces burden on individual nations
o Structured programs - addressing structual issues - ensure long-term stability
o Support for sovereign borrowers - by offering liquidity - Merits of the Federal Reserve as
a LOLR -
o Speed & Flexibility - immediate liquidity during crisis
o Global dollar liquidity - ensure global access to US dollars
o Market confidence - fed interventions help stabilise US and global markets
o Unconditional liquidity - do not require structural reforms - Case studies of their roles -
o IMF = 1997 EAFC, Eurozone
o Fed Res = 2008 GFC, Covid-19 - Challenges & Limitations of IMF -
o Conditionality criticism - can worsen economic hardships
o Resource limitations - may struggle to meet the needs of large-scale global crises
o Slow responses - worsens crises - Challenges & Limitations of Fed Res -
o National focus - prioritises US interests
o Limited to dollar crises
o Sovereignty concerns - some countries may be uncomfortable relying on unilateral institution
10
Q
How costly are financial crises, and have they grown more frequent or severe over time?
A
- Measuring the costs of financial
crises -
o output loss - financial crises = recessions
o unemployment - due to businesses contracting and investment falling
o Bailouts & stimulus packages
o Debt Accumulation - interventions can increase public debt
o Inequality
o Political instability
o Global spillovers - can distrupt global trade and financial markets - Have financial crises grown more
frequent -
o Historical trends
o Empirical evidence - Reinhart and Rogoff (2009), Bordo et al (2008) - Have financial crises grown more severe -
o Severity of modern crises
o Factors contributing to increased severity - globalisation, leverage and risk-taking, larger financial systems
o Improved crisis responses
o Bordo et al (2008) - Costs over time -
o 19th & early 20th century crises
o Modern crises
