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Analysis Of The Current Financial Crisis

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Analysis Of The Current Financial Crisis
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Financial crisis is a situation where the financial value of assets or an economy drops by a significant margin that can cripple the normal functioning of an economy of the affected country. Different economists came forward to explain theories that lead to the different financial crisis especially in the history. These economists include Krugman, Taylor and Blinder. Causes of the crisis include recessions, banking shocks, currency crisis, stock shock, and financial bubbles amongst others. There is evidence of financial crisis I the past. Most of the time, the crisis was brought
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The model has three parts; the aggregate demand equation. The equation relates the domestic spending to real income alongside the interest rate, with the net export. y = D(y, i) + NX (eP*/P, y). The second part is the money-demand equation: M/P = L(y, i) and the third part of the model is the interest arbitrage equation. This part explains that investors should shield themselves against risks and expect the exchange rates to be stable; i = i*
The model has its limitations as no exchange rate is expected not to change with time (Bernanke and Gertler, 1989). The third part is therefore unrealistic.
The figure shows output y and exchange rate e. The line AA shows points at which the domestic rates equals the foreign rates. The line GG outlines the amount of output given a particular exchange rate. When a strong open economy effect is added to the model, a crisis occurs. For example, if foreign currency controls most debts of many firms in a country, the balance sheets will constrain their investment. This will lead to domestic demand having a direct dependence on the real exchange rate; y = D(y, i, eP*/P) + NX(eP*/P, y) . Under these circumstances, when the real exchange rates becomes unfavorable, the firms holding foreign current will not be able to invest. This will lead to triviality at the margin of the direct exchange rate effect. The corporate sector runs bankrupt but the small businesses benefit from weak currency. The effects can be so significant
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