essay plans

Question 1

Why was the emergence of modern central banking slow?

Answer 1

• 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

Question 2

What role did monetary policy play in the Great Depression and other crises?

Answer 2

• 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

Question 3

To what extend did WW1 contribute or cause the Great Depression?

Answer 3

• 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

Question 4

How did the gold standard and monetary policy impact the Great Depression?

Answer 4

• 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

Question 5

How and why did various crises (e.g. US subprime, Eurozone) escalate from national to global levels?

Answer 5

• 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

Question 6

How does contagion occur in financial crises, with specific examples?

Answer 6

• 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

Question 7

Was the Eurozone crisis primarily a government debt, banking, or currency crisis?

Answer 7

• 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

Question 8

Should there be an international lender of last resort?

Answer 8

• 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

Question 9

What are the merits and differences of the IMF and US Federal Reserve as lender of last resort?

Answer 9

• 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

Question 10

How costly are financial crises, and have they grown more frequent or severe over time?

Answer 10

• 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