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Presented By: Group 2B
Economic Crisis and its Symptoms
Economic Crisis:
A situation where a country’s economy faces a
slowdown brought by a financial crisis
Result: Falling GDP, increase in inflation, liquidity
crunch
Symptoms:
• A balance of payment crisis
• Spending by a government exceeds its revenues
• Rapid increase in inflation
Group 2 b economic crisis
BUILD UP OF HOUSING BUBBLE
                             Relaxed lending
      Sub-Prime                                    In 2006 Sub-prime
                           norms, emergence of
                                                    were 50% of total
(Poor Credit History)     non-bank independent
                                                       loans issued
                           mortgage originators




  MBS were rated by                                  Mortgages were
                            SIV converted these
       agencies                                    bundled and sold to
                          into Mortgages Backed
 (Moody’s, S&P), and                              Structured Investment
                              Securities (MBS)
were traded in market                                 Vehicles (SIVs)




                                                   These insurers were
Banks’ capital remain     MBS were insured by
                                                  unregulated and their
intact, they again lent   Credit Default Swaps
                                                  creditworthiness was
           it                     (CDS)
                                                      not assessed
CRISIS
             Revival of                            General price level
           demand and                              was increasing and
            supply side                               housing prices
         pressure caused                          falling due to excess
         increase in price                          supply driven by
               level                                   cheap loans
                                 Increased
                               Interest rates
                                 and falling
                                 mortgage
                                   price




                                Borrowers
Valuation of MBS             defaulted, further               Insurance market
 suffered heavily              housing price                      Collapsed
                                  dipped
European Sovereign Debt Crisis
Causes:
• Rising Government Debt Levels and Maintaining High
  Fiscal Deficit
      Greece (Debt to GDP ratio of approx. 200%)
       Portugal & Italy (Debt to GDP ratio more than
      100%)
• Trade Imbalances
      Increase in government spending decreases the
      national savings thus decreases net export
• Structural Problem of Eurozone
• No Control on Monetary Policy
Possible effect and probable solution
Effect:
• Capital Flight
• Lock Out
• Currency Devaluation
Solution:
• Increase investment and productivity
• Induce economic reforms in the troubled nations
IS-LM model
• It establishes the
  relationship between
  interest rates and real
  output in the goods and
  services market and the
  money market

• The intersection of the IS
  and LM curves is the
  "general equilibrium"
Fiscal Policy & Monetary policy
Fiscal Policy: Government adjusts its levels of spending in order to
monitor and influence a nation’s economy
Example:
Fiscal expansion: An increased government spending or reduction
of taxes.
Fiscal contraction: A decrease government spending or increase in
taxes.

Monetary Policy: Central bank controls the supply of money in the
economy
Example: Monetary expansion via open market
Fiscal Expansion
Fiscal Contraction
Monetary-Fiscal policy mix: German
                Unification
• Policy Mix: The combination of monetary and fiscal policies is
  known as monetary-fiscal policy mix or simply policy mix.

• Fiscal Policy: The German government sharply increased
  government spending and transfers in order to revive eastern
  Germany

• Monetary Policy: After implementing fiscal policy German
  central bank (Bundesbank) feared high possibility of inflation
  hence adopted tight monetary policy to slow down economic
  activity
Monetary-Fiscal policy mix: German Unification
• IS curve from IS1 to IS2 by
  increasing government spending
  hence increasing aggregate
  output
• The LM curve to the left from
  LM1 to LM2 due to tight
  monetary policy (Increase
  interest rates )
• Resulted in fast growth (from
  the fiscal expansion) and high
  interest rates (from the tight
LIQUIDITY TRAP

 Cash additions to the private banking system by the
       central bank fail to lower interest rates


People anticipate adverse happenings like deflation, war
                  etc. and so store cash



Central banks try to lower interest rates by buying
        bonds with the newly created cash
Understanding Through IS-LM Model
• LM curve is horizontal
• Money supply is
  indifferent to interest rates
• Monetary policy is
  ineffective in changing
  output in the market
• Fiscal expansion leads to
  higher output level
• No change in interest rates
• No crowding out
Group 2 b economic crisis

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Group 2 b economic crisis

  • 2. Economic Crisis and its Symptoms Economic Crisis: A situation where a country’s economy faces a slowdown brought by a financial crisis Result: Falling GDP, increase in inflation, liquidity crunch Symptoms: • A balance of payment crisis • Spending by a government exceeds its revenues • Rapid increase in inflation
  • 4. BUILD UP OF HOUSING BUBBLE Relaxed lending Sub-Prime In 2006 Sub-prime norms, emergence of were 50% of total (Poor Credit History) non-bank independent loans issued mortgage originators MBS were rated by Mortgages were SIV converted these agencies bundled and sold to into Mortgages Backed (Moody’s, S&P), and Structured Investment Securities (MBS) were traded in market Vehicles (SIVs) These insurers were Banks’ capital remain MBS were insured by unregulated and their intact, they again lent Credit Default Swaps creditworthiness was it (CDS) not assessed
  • 5. CRISIS Revival of General price level demand and was increasing and supply side housing prices pressure caused falling due to excess increase in price supply driven by level cheap loans Increased Interest rates and falling mortgage price Borrowers Valuation of MBS defaulted, further Insurance market suffered heavily housing price Collapsed dipped
  • 6. European Sovereign Debt Crisis Causes: • Rising Government Debt Levels and Maintaining High Fiscal Deficit Greece (Debt to GDP ratio of approx. 200%) Portugal & Italy (Debt to GDP ratio more than 100%) • Trade Imbalances Increase in government spending decreases the national savings thus decreases net export • Structural Problem of Eurozone • No Control on Monetary Policy
  • 7. Possible effect and probable solution Effect: • Capital Flight • Lock Out • Currency Devaluation Solution: • Increase investment and productivity • Induce economic reforms in the troubled nations
  • 8. IS-LM model • It establishes the relationship between interest rates and real output in the goods and services market and the money market • The intersection of the IS and LM curves is the "general equilibrium"
  • 9. Fiscal Policy & Monetary policy Fiscal Policy: Government adjusts its levels of spending in order to monitor and influence a nation’s economy Example: Fiscal expansion: An increased government spending or reduction of taxes. Fiscal contraction: A decrease government spending or increase in taxes. Monetary Policy: Central bank controls the supply of money in the economy Example: Monetary expansion via open market
  • 12. Monetary-Fiscal policy mix: German Unification • Policy Mix: The combination of monetary and fiscal policies is known as monetary-fiscal policy mix or simply policy mix. • Fiscal Policy: The German government sharply increased government spending and transfers in order to revive eastern Germany • Monetary Policy: After implementing fiscal policy German central bank (Bundesbank) feared high possibility of inflation hence adopted tight monetary policy to slow down economic activity
  • 13. Monetary-Fiscal policy mix: German Unification • IS curve from IS1 to IS2 by increasing government spending hence increasing aggregate output • The LM curve to the left from LM1 to LM2 due to tight monetary policy (Increase interest rates ) • Resulted in fast growth (from the fiscal expansion) and high interest rates (from the tight
  • 14. LIQUIDITY TRAP Cash additions to the private banking system by the central bank fail to lower interest rates People anticipate adverse happenings like deflation, war etc. and so store cash Central banks try to lower interest rates by buying bonds with the newly created cash
  • 15. Understanding Through IS-LM Model • LM curve is horizontal • Money supply is indifferent to interest rates • Monetary policy is ineffective in changing output in the market • Fiscal expansion leads to higher output level • No change in interest rates • No crowding out