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ANATOMY OF A CRISIS Wall Streets financial engineers had packed these loans into complicated financial instruments called CDOs (Collateralized Debt Obligations)
Low in come sub-prime households borrowed heavily from banks and finance companies to buy homes
The size of sub-prime housing loan market was huge at about $ 1.4 Trillion
Housing loans turned bad , the instruments that were based on these loans would lose value
Falling prices dented banks investment portfolios and these losses destroyed banks capital
Peak
Trough
Increase in
Output Employment Investment EXPANSION Aggregate demand
Bank credits
Wholesale & Retail prices
Characterized by Slackening in expansion rate PEAK Highest level of prosperity Downward slide in economic activities The phase of recession begins
Downward slide in growth rate becomes rapid and steady Output, employment, prices etc. register a rapid decline
RECESSION
When the growth rate goes below the steady growth rate depression sets in
Depression begins when Growth is less than zero Total output, employment, prices, bank advances etc. Decline during subsequent period Depression lasts as long as growth rate stays below the stagnated growth rate
DEPRESSION
Phase during which the downward trend in the economy slows down and eventually stops
Economic activities once again register an upward movement TROUGH Period of severe strain on the economy Economy registers a continuous and rapid upward trend in output,employmenr, etc. It enters the phase of recovery
In the recovery phase the growth rate may still remain below the steady growth rate. When it exceeds this rate, the economy enters the phase of expansion And prosperity
BUSINESS CYCLE
BOOM/PROSPERITY
RECOVERY
RECESSION
DEPRESSION
DEPRESSION
PRICE LEVEL FALLS STOCKS ACCUMULATE
PRODUCTION DECREASES
UNEMPLOYMENT INCREASES
RECOVERY
DURING DEPRESSION ONLY CONSUMER GOODS ARE PURCHASED DURABLE GOODS REMAIN UNSOLD OLD DURABLE GOODS EITHER GET CONSUMED OR BECOME OBSOLETE PURCHASE OF GOODS AGAIN BECOMES NECESSARY PRODUCERS PURCHASE THESE GOODS
FULL EMPLOYMENT
BOOM
EMPLOYMENT INCREASE
WAGES RISE
DEMAND INCREASES
PRICES RISE
RECESSION
BEGINNING OF DEPRESSION
Decrease in spending by consumers due to lack of faith in the economy Less consumption would mean decline in demand for products
Banks were reeling under the shock of huge defaults, foreclosure and write off
NEED FOR CONTROLLING BUSINESS CYCLES Harm to business community Create unemployment and poverty
Business Cycles
Monetary Policy
Fiscal Policy
Direct Controls
Conventional Measures
Unconventional Measures
MONETARY POLICY QUANTITATIVE OR GENERAL METHODS MEANT TO CONTROL AVAILIBILITY OF CREDIT IN GENERAL
BANK RATE
COMMERCIAL BANKS ALSO REDUCE THEIR LENDING RATES INDUSTRIALISTS AND BUSINESSMEN FEEL ENCOURAGED TO BORROW FROM COMMERCIAL BANKS THIS WOULD EXPAND CREDIT
COMMERCIAL BANKS ARE REQUIRED TO KEEP RBI A CASH RESERVE OF 8% OF THEIR TOTAL DEMAND AND TIME DEPOSITS
WHEN RBI DECREASES THE CRR THE LENDING CAPACITY OF COMMERCIAL BANKS GETS INCREASED MONEY SUPPLY INCREASES EXPENDITURE INCREASES
APART FROM CASH RESERVE REQUIREMENTS COMMERCIAL BANKS HAVE TO MAINTAIN LIQUID ASSETS IN THE FORM OF CASH, GOLD, AND APPROVED SECURITIES EQUIVALENT TO 25% OF THEIR DEMAND AND TIME DEPOSITS
LOWER SLR REDUCES COMMERCIAL BANKS ABILITY TO GRANT LOANS AND ADVANCES TO BUSINESS AND INDUSTRY
TO INFLUENCE THE VOLUMES OF CASH RESERVES WITH THE COMMERCIAL BANKS TO INFLUENCE THE LOANS AND ADVANCES THESE BANKS CAN MAKE TO INDUSTRY AND COMMERCE
MONETARY POLICY
MEANT TO REGULATE THE FLOW OF CREDIT FOR SPECIFIC PURPOSES TO CONTROL THE ALLOCATION OF CREDIT BETWEEN ITS VARIOUS USES
SLELECTIVE AND DIRECT CREDIT CONTROLS MAGINS FOR LENDING AGAINST SPECIFIC SECURITIES
Reduces bank rate and interest rates of banks Buys securities in the open market
Increases Demand
FISCAL POLICY
Taxes
Govt. Expenditure
FISCAL POLICY
Govt. reduces unnecessary expenditure Raises personal, corporate & commodity taxes
Tends to reduce income and aggregate income Reduces demand for goods and services Stabilizes the economy
Reduces taxes
Stimulates demand
DIRECT CONTROLS
Allocation of resources
Price stability
To affect particular consumers and producers Rationing Wage control Quotas Price Control Export duties Monopoly control Licensing Exchange control