Answer to Question #234732 in Macroeconomics for VTG

Question

The 2007/2008 financial crisis was the worst economic disaster since the Great Depression of 1929. The crisis was the result of a sequence of events, each with its own trigger and culminating in the near collapse of the banking system.

2.1 Discuss the stages of a financial crisis in an emerging economy.

2.2 Explain how a financial crisis may be prevented in the emerging economies.

Answer 1

2.1) The 4 stages of crisis that are identified developing in an economy include subprime mortgage market meltdown, thereafter broader credit market spill overs, which include lacking market as goods tends to lose value. Further, there is liquidity crisis which is epitomized through Bear sterns fallout with other contagion impact on some financial institution. The final stage is commodity price bubble.

2.2) For a financial crisis to be prevented, capital requirements for depository institutions as well as shadow banks needs to be increased and made countercyclical. The liquidity requirements need to be eliminated. Similarly, customer leverage needs to be restricted as customer literacy is improved.