Global Financial Crisis: Causes, Impact, And Reforms
Causes of Financial Crisis
Global financial crisis is considered a significance economic disaster, which shook the financial sector of the world. The financial crisis augmented during 2007, which directly impacted the subprime mortgage sector of USA. The financial crisis started with the high default rates in the mortgage loan, which further escalated the problems for the financial market all over the world. The analysis of the global financial crisis is being conducted, which directly highlights the possible causes that led to the augmentation of the economic crisis. Further evaluation has been conducted whether the financial crisis can be repeated again in future, which can directly affect the operations of the financial market. Further evaluation is conducted on scale and impact of the GFC on the economy of different countries, which halted the operations of their financial sector. Lastly, evaluation on the actual actions and proposed plans for controlling the GFC is also conducted.
The financial crisis of 2008 was led by the subprime mortgage crisis that started in US due to the high level of defaults in the housing loan sector. The financial crisis was led by the subprime mortgage catastrophe but other factors also coupled and contributed to the financial crisis of 2008. The bankruptcy of the biggest financial service provider Lehman Brother is considered to be one of the major events, which sealed the augmentation of the financial crisis for the US government and the financial sector of the world. There were many indications and this portrayed the problems regarding the current financial sector of the country, which negatively affect the financial sector of US (Choudhry, Hassan and Shabi 2015).
The major contributor to the Global Financial Crisis was the GATS agreement, which allowed the financial sector of US to trade in global market and design different level of derivatives and instruments that increased the liberation of the organisations. The agreement allowed the financial sector companies to deal with other countries and provide them investment options, which increased global trade and liberations. This led to the involvement of financial and investment banks in the mortgage sector (Claessens and Van 2015).
The possible causes of the financial crisis are depicted as follows.
Imbalance in the world trade:
The main factors that contributed to the financial crisis of 2008 were the imbalance in world trade, which occurred during 2001. This was the year when China joined the World Trade Organization and produced cheap Exports to flood the Global Trade System. This shift in manufacturing system mainly forced China to increase is exports all over the world while US manufacturing started to reduce. The trade imbalance allowed China to increase the trade surplus, while US trade deficit started to increase, as the manufacturing shifted from US to China. The further evaluation of trade balance helps in detecting that the value increased from the levels of $69 billion in 1999 to $256 billion in 2007. This increment in trade deficit of United States directly contributed to the decline in its Industrial and consumer goods production system. The organizations were shifting their production to China for reducing the level of expenses incurred in producing the product. This directly shifted the economy of America from manufacturing to service (D’souza 2016).
Imbalance in the World Trade
Impact from federal reserves and people bank of China:
One of the major events that contributed to the global financial crisis was the decisions made by Federal Reserve of America and People Bank of China. The augmentation of the Chinese exports in the world market was directly supported by the manipulations that were conducted by people Bank of China. The Chinese government directly manipulated their currency against US dollars and kept the Yuan the value to increase export all around the world. The people Bank of China manipulated the currency to support their exports. Major mistake that was made by Federal reserves of America was lowering the interest rate up to 1%, which increased the leverage capability of organization taking out loans for conducting their operations. Moreover, to support the Global change in trade Federal Reserve also started to print more dollars to support the international trade, which was being, conducted in US currency. The combined action of FED and people Bank of China directly created a catastrophic condition for America, which laid the foundations of the global financial crisis (Gendron and Smith-Lacroix 2015).
Change in consumption pattern of United States:
The change in consumption pattern of United States was also a major contributor to the trade imbalance, as organization and citizen increase their imports from other country. The high demand of import started to decline the output that was conducted in US. High imports directly increased the trade deficit of US, which was supported by extensive borrowings inform of bonds to support government spending. Moreover, China used its financial surplus to buy US Treasury bills and bonds, which in turn increases the fiscal deficit of the country. The continuous measure that was conducted by China increased the trade deficit by 1.5 Trillion in 2007 (Leiss, Nax and Sornette 2015).
There is a possible of the GFC to be repeated in future, as the current situations are not projecting secure financial trajectory. There are different stories that have been emerging all around the world after the financial crisis of 2008, which directly indicates that another crisis can occur in future. Greece was in the brink of default, which is a major concern for the financial sector of the world, as the country contributes heavily to the European Union. Greece being the defaulter in payment would directly result in negative financial position of the European Union. Furthermore, the Brexit also a major event that could lead to the next financial crisis if United Kingdom does not formulate an adequate deal while leaving the European Union. Currently many events are taking place around the world, which can be a major contributor to the next financial crisis (Moore and Mirzaei 2016).
Impact from Federal Reserves and People Bank of China
One of the major evils that are currently happening in United States is the shutdown of the government, which is directly eroding the GDP growth of the country. Analyst have relatively indicated that the longest government shutdown in history who directly Erode all the GDP growth which will negatively affect the current financial sector. Therefore, affecting the US economy would directly affect the financial sector of the world, as America is considered to be a major contributor to the world economy. The events in recent years have highlighted different methods and ways in which the financial crisis could occur if governments do not operate adequately.
The financial crisis dried up the liquidity conditions in the world market, which was considered catastrophic for the countries that were being affected by the crisis. Therefore, adequate reforms were proposed, which helped the governments for reducing the negative impact of the financial crisis. The reforms used by the government are depicted as follows.
Using the Stimulus package:
Stimulus packages that were designed by the government directly helped in minimizing the negative impact of global financial crisis on the financial sector. The stimulus package comprised of monetary benefit to the financial sector banks that were compromised by the negative impact of financial crisis. Governments around the world directly launch the package to curve the recession and take out the economy from the recession. The consumer spending started to decline exponentially during the financial crisis, which reduce the industrial output and increase unemployment in the world. The stimulus package acted as an injection to the recession, which helps in increasing the cash flow in the economy and curbing the consumer spending (Lins, Servaes and Tamayo 2017).
Using the rescue plan:
The rescue plan was designed by United States to fight the financial crisis that was hampering its financial sector. The rescue plan of United States covered a package of $800 billion, which will be infused in the financial sector to pull the economy out of recession. The aim of the financial rescue plan was to save the most important investment bank and insurance companies from the clutches of the finance share price. The investment bank and insurance companies lead to bankruptcy due to the financial crisis, where the rescue planned prevented their further financial deterioration. Many countries that followed the same rescue plan, as United States to save their finance and insurance companies from the brink of bankruptcy. These methods for temporary in nature as a increase the cash flow in the market which allowed in financial sector to conduct their operations smoothly without straining more on the economy (Floyd, Li and Skinner 2015).
Change in Consumption Pattern of United States
Monetary policy change in central banks:
Monetary policies were changed by the central banks to halt the progress of the financial crisis. Central banks all over the world directly reduced their interest rate drastically to curb the problems from the recession. The central bank by lowering the interest rates directly reduced the cost of borrowing for private business and consumers for improving the commercial activities in the country.
The proposed reforms that were not used by the governments are depicted as follows.
New Global Financial System:
The new global financial system was proposed where is the International Monetary Fund will play a major role in regulating and auditing the global financial system. The International Monetary Fund should adequately play a vital role in conducting regulations and ensuring the financial market mechanism, which will prevent future collapse (Mera and Renaud 2016).
Change in government fiscal policies also need to be conducted which might eventually help in reducing the negative impact of the recession. The careful use of government fiscal spending and stimulus packages directly help in minimizing the negative impact of recession on the economy. The public spending need to be focused on infrastructure and construction activities, which will help in growing the economy. Moreover, the bailout program needs to be focused on unemployment benefits, and subsidiary programs, which will eventually help in increasing the spending that will have long term benefits to the economy. The government fiscal policies need to target long term growth and reduces short term objectives, which directly was in the future growth of the country (Benmelech, Meisenzahl and Ramcharan 2017).
Figures 1: Countries effected by the GFC
(Source: Chen et al. 2016)
The above figure highlights the regions that were affected by the Global financial crisis. From the evaluation it is detected that developed countries that directly affected by the financial crisis which shrunk their GDP growth, which became negative. The reasons that were affected by the global financial crisis were Western hemisphere, Middle East and North Africa region. The Commonwealth of independent States directly decline exponentially during the financial crisis. Therefore, it could be assume that the world economy started to reduce negative GDP during the financial crisis, which indicates an alarming rate for the finance effect of the country. Countries like United Kingdom, European Union, Russia, Middle East and Korea were directly affected by the financial crisis of 2008. The GDP contribution of European Union declined to negative levels during the financial crisis. This highlighted that developed countries having exposure to the US economy had the biggest fall in their GDP growth rate (Gilchrist et al. 2017).
Possible Reoccurrence of GFC
Conclusion:
The assessment directly evaluates all the relevant information regarding the global financial crisis that occurred in 2008. The measure that was taken by the government around the world for reducing the negative impact of the financial crisis is also discussed. However, the financial crisis increases the problems for the world economy, as the measures that were used by the government did not completely nullify negative impact of the financial crisis. Countries that were affected by the financial crisis was also discussed, among which were United Kingdom, European Union, Russia, Hong Kong, and Singapore. Lastly, adequate measures that could be adopted by the government all around the world is also discuss which might prevent future financial crisis.
References
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