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The Current Financial Crisis

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Frederic Mishkin makes the point in the text, The Economics of Money Banking, and Financial Markets (2010) that “Banks and other financial institutions are what make financial markets work. Without them, financial markets would not be able to move funds from people who save to people who have productive investment opportunities.” (p.7). The movement of funds between savers and those with productive investment opportunities is the means of creating growth. When people lose confidence in the economy this activity freezes or weakens, consequently, asset prices decline, unemployment rises and companies default as was the case of Lehman Brothers in 2008. The freezing of the flow of money is a financial crisis. Today, the global flow of money is at risk.

This risk is a result of Debt and Credit imbalances: "Persistent trade surpluses in some countries and deficits in others did not reflect a flow of capital to countries with profitable investment opportunities, but to countries that borrowed to finance consumption or had lost competitiveness. The result was unsustainably high levels of consumption (whether public or private) in the US, UK and a range of other advanced economies and unsustainably low levels of consumption in China and other economies in Asia, and some advanced economies with persistent trade surpluses, such as Germany and Japan."

The debt and credit imbalances have created global systemic risk as economic markets have become more interdependent. The European debt crisis constantly weighs on global markets. The fall of Lehman Brothers in 2008 highlighted the systemic risk of institutions that were deemed “Too large to fail.” The European debit crisis highlights the risk to the global economy should specific c...

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...xt makes the point that global growth without the proper level of legal, financial and political expansion can be a big problem. A notable example is the Soviet Union. In the 1950s and 1960s they had similar, “high growth fueled by a high savings rate, massive buildup of capital, and shifts of a large pool of underutilized labor from subsistence agriculture to manufacturing.” (p.189). Once the growth started to slow, they didn’t have the financial infrastructure in place to sustain their economy. As the economy becomes more global the exposure risk of the financial structure of countries like China becomes more important. We are living in a time that gives us a unique opportunity to watch the effectiveness of policy response to disruptions in financial markets. As the exposure risks become more global there will be an increasing need for global policies responses.
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