Introduction and Overview
The subject of financial development and growth has always been an area that perceived great attention over the past two decades. One of which is financial repression, was what Cole (1974) referred to as a term used characterize a state in an economy where, interest rates are averted from determining the equilibrium rate of demand and supply of money. In other words, it is a set of government rules and regulations, and other restrictions other than that of the market that inhibits the financial intermediaries of an economy to maximize their output (Ito 2008 p. 430). The genesis of this theory was around the 1970s pioneered by two renowned economists Edward S. Shaw and Ronald I. McKinnon.
With inference from this definition, I define financial repression as government activities and regulations put in place to reduce debt nevertheless been argued by many economists as a having a mixed effect on economic growth. Historically, financial repression has involved a number of government policies; interest rates controls, high bank reserve requirements, capital controls, rigid financial sector entry requirements, liquidity ratio requirements, restricted credit allocations, government control and ownership of banks and credit ceilings (floors) among many others Xu G. & Gui B. (2013).
The remaining part of this paper is arranged in the following order. There is a brief discussion of the financial repression theory, which is followed by critique of the theory. The next is an evaluation of the complicated relationship between financial repression and economic performance, then a case study of china and finally the conclusion and remarks.
The Financial Repression Theory
Financial repression comes to existence w...
... middle of paper ...
...gative relationship between interest rate repression and basic macroeconomic factors such as economic growth, savings and investments. For instance, Fry (1978) tested the work of Shaw (1973) and McKinnon (1973) and their alternative theories for seven LDCs (less developed countries) in Asia and concluded that real interest rate has a significantly positive effect on domestic savings and economic growth.
Reports by Fry (1997) suggests that measuring financial distortions with black market exchange premiums rates and real interest rates squared lowers investment ratios eventually leading to a reduction in growth output. In the same vein, Roubini and Sala-i-Martin (1992) also revealed that financial repression is negatively related to growth while controlling other growth determinants; hence interest rates (bank-reserve requirements) correlates inversely with growth.
..., restrictive monetary policy is used to slow the GDP growth rate and reduce the inflation rate. All in all, both monetary policies are used and to alter inflation and GDP growth rate and then to support economic activity.
Shahrokhi, M. (2011). The global financial crises of 2007-2010 and the future of capitalism. Global Finance Journal, 22, 193-210. doi: 10.1016/j.gfj.2011.10.010.
The decades after the Civil War rapidly changed the face of the United States. The rapid industrialization of the nation changed us from generally agrarian to the top industrial power in the world. Business tycoons thrived during this time, forging great business empires with the use of trusts and pools. Farmers moved to the cities and into the factories, living off wages and changing the face of the workforce. This rapid industrialization created wide gaps in society, and the government, which had originally taken a hands off approach to business, was forced to step in.
The deregulation of the financial market resulted in great economic loss rather than gain due to the fact that the market did not satisfy the conditions required for Smith’s ideal economy to work; for a free market economy, there must be a competitive market, perfect information, and extremely low if any transaction costs (Lecture 09-Capitalism). In reality, the market had an imbalanced competitive market due to the sheer magnitude of firms such as Goldman Sachs, false information circulated by the firms in order to trick clients into making dicey investments, and high transaction costs due to banks forcibly driving up prices (Taibbi 2010). Therefore, rather than an increase in efficiency, the economy experienced a sharp decline as a result of the corrupt, greedy enterprises of Goldman Sachs and other Wall Street
The Enrons and Worldcoms made it clear that the financial markets cannot be left under the auspices of corporate directors and officers, without oversight authority. "The corporate abuses and fraud that Enron exemplified, while not a first in the financial markets, they were certainly a first in terms of the magnitude of the losses to stockholders and the confidence the public reposed in the financial sector (Bequai 2003)." As a result of the stock market crash of 1929 regulations such as the Securities Act of 1933 and Securities Exchange Act of 1934 were established to prevent such practices as those that contributed to the downfalls of Enron and Worldcom.
This essay will examine the causes of the 2008 Global Financial Crisis (GFC) from a Marxist perspective. This paper will specifically examine and critique how Marx’s Theory of Crisis can be applied to understand and interpret the underlying structural causes of the 2008 Global Financial Crisis.
In the study of macroeconomics there are several sub factors that affect the economy either favorably or adversely. One dynamic of macroeconomics is monetary policy. Monetary policy consists of deliberate changes in the money supply to influence interest rates and thus the level of spending in the economy. “The goal of a monetary policy is to achieve and maintain price level stability, full employment and economic growth.” (McConnell & Brue, 2004).
Loungani, Prakash, and Nathan Sheets. "Central bank independence, inflation, and growth in transition economies." Journal of Money, Credit, and Banking (1997): 381-399.
If financial markets are instable, it will lead to sharp contraction of economic activity. For example, in this most recent financial crisis, a deterioration in financial institutions’ balance sheets, along with asset price decline and interest rate hikes increased market uncertainty thus, worsening what is called ‘adverse selection and moral hazard’. This is a serious dilemma created before business transactions occur which information is misleading and promotes doing business with the ‘most undesirable’ clients by a financial institution. In turn, these ‘most undesirable’ clients later engage in undesirable behavior. All of this leads to a decline in economic activity, more adverse selection and moral hazards, a banking crisis and further declining in economic activity. Ultimately, the banking crisis came and unanticipated price level increases and even further declines in economic activity.
Smith stated in the Wealth of the Nation (1776), “Civil government, so far it is instituted for the security of property, is in reality instituted for the defense of the rich against the poor, or of those who have some property against those who have none at all.” (Patil) Shay’s Law implies supply creates its own demand and demand is not based on production or supply. Schenkel 2 The last assumption is that savings will equal the investment which will lead to equilibrium; however, Classical theorists are realist and know this will not always happen, thus, they believe the flexible interest rates will help with the equilibrium.
With fewer dollars available as savings to banks and other financial institutions, interest rates are higher for both savers and borrowers than they would otherwise be. That makes it more costly to finance investment in factories, equipment, and other goods, which slows growth in the GDP.
The bank failure in Jamaica illustrates how negative mindsets and behaviors can devastate the financial system and disrupt economic growth. The primary role of any bank is to safeguard its customer’s money, offer interest rate on deposits, lend money to creditworthy individuals, and make sound investment decisions to maximize shareholder value. Because of rapid economic growth between the late 1980s and early 1990s in Jamaica, the Central National Bank (CNB) and Worker’s Savings and Loans Bank (WSLB) loosened their monetary policies, provided preferential interest rates and extended credit beyond what was reasonable to members of its own board of directors, managing directors, and officers of the bank. These actions posed significant risks to the bank and its future.
Interest rates and the effects of interest rates on the economy concern not only macroeconomists but consumers, savers, borrowers, and lenders. A country may react and change their interest rates, according to the prosperity of their economy. Interest rates, is the percentage usually on an annual basis that is paid by the borrower to the lender for a loan of money (Merriam-Webster). If banks decided not to use interest rates, it would be impossible for others to be able to take out loans and therefore, there would be far less spending money in the economy. With interest rates, this allows banks to take a percentage of the consumer’s money and loan it out to others, thus allowing economic growth to be possible. Interest rates also allow lenders to have a “safety net” which is necessary because there is a possibility that the borrower would be unable to pay back a loan to the bank. A nation’s interest rates can be raised or lowered and these shifts in interest rates correlate directly to aggregate demand. Aggregate demand, is the total demand for final goods and services in an economy at a given time (Business Dictionary). A nation uses interest rates for economic growth or to help prevent inflation. When economic growth is needed a nation would lower their interest rates. However, if a country is concerned about inflation, they may choose to raise their interest rates. When interest rates, raised or lowered, will have a negative or positive impact on consumers, and have a positive or negative impact on investors.
Warwick J. McKibbin, and Andrew Stoeckel. “The Global Financial Crisis: Causes and Consequences.” Lowy Institute for International Policy 2.09 (2009): 1. PDF file.
While banking and financial institutions have play an important role in contributing the economic growth by collecting and allocating the resources to those who in need of finance, it also can bring the financial chaos to the economy as well. Since this industry is a sentitive and fragile one, the banking superivision is required to monitor on the banking system aiming to identify and measure risks in order to protect not only the financial institutions but also the customers from the contagious risk that would happen without any alert. Moreover, banking supervision is established in order to protect depositors against avoidable losses, thereby contributing to confidence in the financial system and the