Econ 126 final
15. How do Acemoglu and Robinson describe the inclusive institutions that led up to the industrial revolution in England? (30 points-10 elements)
-Acemoglu and Robinson state that starting with the Glorious Revolution, Parliament is determined to erase absolutist policies. This was evident by the presentation of the Declaration of Rights to William of Orange. From that point, "authority and decision-making power switched to Parliament"(191) and "English people now had access to Parliament, and the policy and economic institutions made in Parliament"(192). (These are all examples that they given in the book) After Parliament was handed control of state policy, "property rights eroded under the Stuarts were strengthened"(194). Parliament promoted manufacturing rather than taxing and impeding it, this was evident by the abolishment of the "hearth tax" (an annual tax for each fireplace or stove). Redistributed the tax burden by taxing land. Parliament abolished all monopolies even those that existed primarily overseas (see the African Royal Company). Parliament passed acts and legislation that would expand the market and the profitability of woolen textiles. Reorganized property rights in land, thus "eliminating archaic forms of property and user rights". Also went ahead with the creation of the Bank of England in 1694, as a source of funds for industry which instigated a "financial revolution"--allowed a "great expansion of financial markets and banking" and loans available to anyone that could provide the necessary collateral. The "capability and capacity of the state increased in all directions"(196) which was due to the presence of state centralization and pluralism. After 1688 Parliament began to improve the ability to raise revenue through taxation--this is important to maintaining the size and influence of the state (this is still inclusive). Finally and also after 1688, "the state began to rely more on talent and less on political appointees"(197) which was key to the development of a powerful structure. Other things to consider: The separation with the Catholic Church made way for the possible centralization of the state. Also, the conflict between the King and Parliament was frequent, the King would attempt to reinforce absolutist policies but there was always pushback and sometimes revolution until William of Orange's arrival in 1688 (Glorious Revolution). Adding to this point, the Statue of Monopolies(1623) was the first attempt to deal with domestic English monopolies. After the English Civil War and the Glorious Revolution, crown lost power. Parliament was established to protect the interests of the poor (creation of inclusive institutions) which increase market incentives and establish property rights. Lead to higher revenue. 3 aspects: First Civil War; then Glorious revolution, constrain power of king; government forced to create inclusive institutions and incentives. Summary: It's all thanks to the Glorious Revolution. "foundations laid by the inclusive political institutions brought about by the Glorious Revolution. It was the Glorious Revolution that strengthened and rationalized property rights, improved financial markets, undermined state-sanctioned monopolies in foreign trade, and removed barriers to the expansion industry. It was the Glorious Revolution that made the political system open and responsive to the economic needs and aspirations. These inclusive economic institutions gave men opportunity and incentives to develop their skills and ideas."(idk the page number but its in ch.7 under the subtitle "Why in England?") Also the person who wrote "this all I got" has good evidence from the Glorious Revolution to support this claim
10 a. Economists describe the interest rate on sovereign debt as sometimes being determined through a "fragile" equilibrium. Explain what is meant by a "fragile" equilibrium in this context. 8 Points - 3 elements
"Fragile" simply indicates that confidence in the repayment of loans can change quickly and thus change interest rates (confidence if a nation will default or won't default). As governments primarily borrow short term, small changes in confidence can lead to large changes in interest rates. Confidence in the market can lower interest rates and make debt repayment easy. If confidence drops, interest rates increase and the burden of debt gets to high for the borrower and is often impossible to repay.
c. How were global financial institutions involved? 4 points - 2 elements
- IMF fuels huge loans to eliminate cronyism, raise interest rates, and cut gov spending. Closed bad banks to win back market confidence and stimulate growth. At best the IMF policies avoided one vicious circle to start another.
Use a mini example to illustrate how moral hazard and bank lending can induce a financial crisis. 8 points - 2 elements
2008 crisis. Bank A lends to Bank B at a highly leveraged rate of 30:1. Bank B uses this money to invest in risky mortgage backed securities knowing that themselves and consumers are protected if a default occurs (FDIC insurance and Gov. wont let bank fail if it's big enough). However, this creates a price bubble. Once the bubble pops and the price of those assets crash, Bank B can no longer pay bank back the money it borrowed and defaults. Bank A in distress tries to call bank all is loans and other banks frantically sell assets for half their worth to meet demands. A domino effect ensures. Thu, Moral hazard (lack of fear of consequences) created high leverage in the banking system. This leverage was used in risky investments and once those investments failed and banks defaulted, they whole financial system can go down.
12. According to Dani Rodrik: (30 points) a. What is the globalization trilemma (explain in detail)? 8 points - 4 elements
3 essential features: Globalization (Deep Economic Integration) Democracy (Democratic Politics) Nation state **a government policy can only have two of these three at the same time
Explain why a high prevailing degree of leverage makes financial firms more vulnerable to failure and the financial system more vulnerable to crisis. 2 points-1 element
A high amount of leveraging between financial firms is very risky as it creates conditions that will deeply worsen a downturn. Suppose a bank leverages at a 30:1 ratio hoping to turn a huge profit in 10 years. If an investment goes under or an economic downturn happens than that bank will default on the loan. The lending bank now is out of that money and must collect from other banks to regain its losses. If it can't collect because other banks leveraged and can't pay their debts back, it creates a domino effect: leading to a huge financial crisis such as 2008.
What problem might an economy suffer once its credit market crashes? What are some characteristics for such a situation? 6 points - 3 elements
A liquidity trap. Bankruptcies, low interest rates, and increasing deflation will arise as consumers hold onto safest assets (cash and bonds) as economic growth shrinks. High savings rate and low interest rates. Injection of money lowering interest rates fail to increase spending.
c. Give examples of different countries' choices facing a policy trilemma. 20 points - 8 elements
Additionally can discuss Argentina, Mexico (Tequila Crisis), and Brazil (all tied currencies to the dollar and elected to have free capital mobility and limited ind. policy) Before and during the Asian Crisis of 1998, Thailand faced the policy trilemma. As their economy kept expanding, Thailand needed to decide which two of the following it desired to utilize: free capital mobility, fixed exchange rates, or independent monetary policy. Prior to the crisis, Thailand pegged the Baht to the dollar, thus Thailand engaged in fixed exchange rates. Along with this, Thailand elected to have free capital mobility though allowing high rates of foreign investment to enter the country to fund the housing bubble. However, utilizing these two aspects proved fatal as Thailand couldn't to engage in independent monetary policy (as the trilemma states a nation can only utilize ⅔). Once the housing bubble burst, the Baht steeply devalued. To stop a huge decline in devaluation, the government floated the Baht (gave up fixed exchange rates to enact indp. Monetary policy to attempt to save economy). But since the value already crashed, the loans from foreign countries must be paid back more than what was originally borrowed. In short, Thailand faced the policy trilemma which ultimately led and prolonged the Asian crisis of 1997/98. The European Union is another example. Members of the European Union particularly the weaker PIIGS (Portugal, Ireland, Iceland, Greece and Spain) must give up independent monetary policy to allow for fixed exchange rates and free capital mobility with other countries (as the euro is the single source of currency among union members, so one country in particular can't devalue the currency). Give up monetary policy to be apart of the union and have access to free capital mobility. Thailand - had to devalue currency and stuck themselves in a crisis -they had a weak Independent monetary policy because they couldn't keep a fixed exchange rate and free capital mobility.
11 Why was the replacement of feudal political fragmentation with effective central government a key change that was favorable to capitalist economic development? 6 points-2 elements
As capitalist development requires more than just markets, the fall of feudal Europe provided a strong foundation for a dual feedback loop between markets, political institutions and social mores to arise. Two major loops are key: markets favor improved technology and improved technology expand markets. (improved transport and navigation led to discovery of new world and cheaper goods allowed for mass expansion of markets). Also the decentralization of feudal powers allowed for cultural evolution through experimentation. Cultural evolution led to favoring economic dominance just as much as military dominance.
How did heavy reliance on Repo financing specifically make US investment banks vulnerable to a loss of confidence? 1 point-1 element
As many investment banks were using repo loans (short term borrowing from dealers in government securities and were lent on an overnight basis and repaid back the next day) they ran the risk of failure of an entire company overnight. Many Repo loans used mortgaged back collaterals as they financed approximately 30% of assets. Once the market stopped accepting these MBCs as collateral (as they weren't worth what they were labeled) investment banks began failing due to this loss of confidence.
What connection is drawn between distinctive goals of Japanese enterprise and Japan's bubble economy of the 1980s? 6 points - 3 elements
Because of the goal to increase growth, firms have incentive to invest in riskier assets Implicit commitment by government to bail out certain firms and banks Banks lent to firms without properly monitoring performance Firms invested profits in the inflated stock market Banks extended surplus cash for real estate speculation This increases leverage and leads to the development of a bubble economy Riskier investment lead to insolvency Low interest loans used to invest which contributed to a growing bubble Firms invested profits in the inflated stock market Banks extended surplus cash for real estate speculation Monitoring checks on Japanese firms were weak
What evidence is there in favor of the applicability of the model to feudal and early modern Europe. (5)
Before 1800 birth rates were pretty constant, and for a minute (12-18) real wages didn't really change. Engel's law held, where poorer families had to spend a larger % of income on food. Also black death clapped hella people and land was plentiful. People started inhabiting the land and distribution of land fell because the rich copped a bunch of land. Real wages fell and rent went up.
According to Gregory Clark, what conditions must be met for the malthusian model to apply (3)
Birth rate is determined by customs, but rises when living standards rise Death rate falls as living standards rise Living Standards fall as population rises All in the aggregate
What course does Rodrik recommend for dealing with the trilemma? 10 points - 2 elements
Bretton Woods compromise with thin layers of globalization (as to protect democracy, individual nation state while allowing some aspects of globalization) Allow increased global labor mobility. This can be done through relaxing restrictions on the movement of international workers which would allow for the largest possible gains for the world economy
For what time period does Gregory Clark believe the malthusian model applies (1)
Clark believes this applies to Europe pre Industrial Revolution
How would Acemoglu and and Robinson answer: What is the most effective way to help move billions of people from the rut of poverty to prosperity? (2)
Create inclusive institutions that promote prosperity, create incentives, technology, innovation, Separate power of the elite to represent poor.
Why did monarchs seek political alliances with towns as part of a strategy to obtain greater centralized political power? 18 points-3 elements
Crown wants more money, so they allied with towns to gain more revenue. European politics had changed from automatic to oligopolistic (multiple nations vs multiple nations) so needed citizens to join war effort as being allied with towns led to easier recruitment. Also led to little inside resistance to power. They cut out the lords in order to centralize political power. Towns seek secure property rights and expanding commerce. By allying with towns, there is little threat to power (towns are home to most densely populated bodies of people). As towns have most population, good relation will allow for more individuals to join army as nation expands. Towns are centers of learning and innovation. New technology and ideas are key to sustainable growth. If a monarch wanted to stay in power he needed the help of towns to progress both the economy and the military. Crown seeks tax base. Crown can levy taxes to fund wars, military, expansion etc...
Give 2 reasons why a sovereign should not default? 4 points - 2 elements
Default harms nation's reputation in international relations Trade is very dependent on short term credit and disruption to lending may also disrupt on trade and disrupt Foreign Direct Investment(FDI). Right to borrow in the future/access to international markets Legal rights of creditors to seize foreign debtors assets in own country
18. What is sovereign debt? (30 points) (lecture 13) a. What are the possible reasons for Sovereign Default? 6 points - 3 elements
Definition of Sovereign default: payment on current debt exceeds expected future borrowing Government is simply unwilling to repay its debts. There is no supranational mechanism to collect debt hence they are not held accountable. more possible reasons: internal conflict (war) prevents gov from being able to pay back loans External market shocks (oil shocks etc)
17. Describe the 2008 great recession. (30 points) (most info is on lecture 18) a. What was the cause? 6 points - 6 elements
Deregulation of banks→ Subprime mortgage lending due to moral hazard through predatory lending and FDIC insurance; anyone can get a mortgage backed a 'AAA' approved CDO security and if investments failed, creditors money was safe. Shadow financial system → no regulation and system utilized new derivative instruments to evade existing regulations→ actual banks engaging in more risky investments to compete (crisis of negative expectations) Housing and Speculative bubbles Aggregate debt becomes unsustainable → leverage climbs to unprecedented levels---> repo loans to finance asset purchases using mortgage backed-securities (CDOs) as collateral. (once market realized weren't AAA, collapse of companies, starting with Lehman Brothers, due to lack of confidence) Lack of government intervention: Greenspan warned earlier of imprudent mortgage lending → he refused to regulate because of his free market philosophy → moral hazard worsens Mortgage assets fall in value + leverage = hedge funds/financial institutions distress sell assets → weakens confidence (similar to Great Depression beginning in 1929)
Why are even solvent banks vulnerable to bank runs? 9 points-3 elements
Distress of sale of assets Not able to determine bank's solvency or insolvency Market confidence
The success of infant industry policies is often questioned on the grounds that it is difficult for the government to know which industries to target. How did the Japanese government select industries to target before WWI? 6 points - 3 elements
Diversified by lending to multiple industries but lent primarily to military industries such as steel and shipbuilding (both of which were successful). Other invested industries include automobiles (successful) and coal and shipping (unsuccessful past WW2). As no one knew which industries would be successful, Japan targeted all their heavy industries (Rich Nation, Strong Army) by protection through tariffs then opening up the industry to trade liberalization, Japan created a high likelihood these industries would succeed when entering the global market. Learned from failures and employed industrial policy which benefited heavy industry.
What are some possible policies that can cure the problem in part c and intuitively explain why they work? 8 points - 4 elements
Expansionary Fiscal Policy— increase government spending, cut taxes to stimulate investment/spending. Open programs to create jobs to increase spendable income and create jobs. Expansionary Monetary Policy —lower interest rates on banks to stimulate investment/growth and create expectations of future growth (shower banks with cash)
According to Paul Krugman's book, The Return of Depression Economics and the Crisis of 2008, what policies are best used to combat a liquidity trap? 9 points -3 elements
Expansionary fiscal policy: Cut taxes on income that will be spent quickly if untaxed, increase gov spending, etc... provide incentives to spend money rather than hold onto it. Policy that creates expectations for future inflation (ie. flooding banks with cash to avoid deflation) Recapitalize the banking system so the trap doesn't happen continue/happen again Anything to avoid deflation and increase spending now
What measures did Japan take to promote infant industries before WWI? 10 points - 5 elements
Followed the "Rich Nation, Strong Army" Meiji Restoration approach High level of state involvement that promoted investment Government invested in heavy industry (iron, steel, shipbuilding, and railroads) Economic growth became main objective of the state Government established a number of public enterprises Even if failed, social benefit from learning Sent observers abroad to study foreign technological/bureaucratic methods Imported technical experts Adapted this technology through innovation
What was the impact on living standards of the poor and of the general population? Explain. (12 points)
For many people, the industrial revolution did not lift them out poverty immediately, and the average person did not make gains (real wages remained the same). Afterward, however, during the 1830s and 1850s, real wages of the poor began benefiting from efficiency gains, and thus the general standard of living also increased. Poor and general population were more likely to become ill (due to pollutants, crowded cities bad sanitation issues) and bad work conditions (standard of living slightly decreased) but overtime standard of living increased as efficiency gains came about. 6 aspects: Beginning, large supply of labor, low wage; then demand equals supply, high wage; nowhere in the world better; living standard increases, but poor is worse because bad work environment in factory; over time gains lessen the bad living standard; farm labors have lowest wage, living standard bad
b. What was the timeline? 6 points - 6 elements
Found this rough timeline in 8 days article October 2007: Signs of asset bubble followed by first signs of financial collapse (high defaults on loans) March 2008: Bear Stearns and major investment banks begin to face bank runs. Government brokers a deal with JP Morgan to buy Bear Stearns. September 6, 2008: Fannie Mae and Freddie Mac are placed into conservatorship (government took them over) . Government state entities are bankrupt but still operating. September 13-15, 2008: Meltdown Monday after Lehman Weekend. Over the weekend FED, CEOs and other officials discussed what would become of Lehman Brothers. Yet government allows them to fail September 16 2008: Fed gives two year 170 billion loan to ensure AIG to stop financial collapse. Took 90% of AIG stock as collateral. September 19: Outline of TARP is presented to President Bush with goal to stop economic meltdown October 3 2008: President Bush signs TARP into effect to stop economic meltdown
According to Reinhart and Rogoff, why do many countries default on sovereign debt even at external debt/GDP ratios as low as 60 percent? 8 Points - 2 elements
Governments are simply unwilling to pay their debts There is no supranational mechanism to collect debt from a sovereign government
How did government policies in Japan and the United States foster moral hazard among financial firms? 4 points - 4 elements
Governments in both countries ensure that firms will be saved from failure Example of FICA and FSLIC in US (institutions that insure deposits) Banks that are insolvent will tend to take on more risk to avoid bankruptcy (Banks also have nothing to lose if they fail, because they are already going to be bankrupt.) Savings and Loan failure Deregulation of financial sector in both countries also encouraged more risky investments Japanese culture that saw bankruptcy as disgrace Encouraged members of Keiretsu to help ailing members, even if it didn't solve the core problem Japan - moral hazard comes from bank/firm relation that encourages low interest loans for high risk investment - banks refuse to acknowledge bankruptcy of invested firms, continue to funnel money → zombie firms - banks weakly monitored performance which allowed for over risky investments U.S. - moral hazard comes from FDIC depositors insurance such that bankruptcy comes at cost to the Fed, commercial bank is not faulted - banks use derivative systems to evade regulation of debt:equity - managers acting in their own self interests due to weak constraints
14. Compare and contrast the causes of the Great Depression with the causes of the Great Recession. 30 points - 10 elements
Great Depression Didn't know how to stimulate the economy to that extent Responded slower Less regulations on banks and make them more likely to go bankrupt Tariff limit transactions between countries Bad gov't policy Less cautions for lending money Stock market crash Bank failures/bank runs Asset price bubbles (Speculation and housing) All these and hoarding of money led to deflation Great Recession Had an idea of what was going to happen Banks weren't sure and left money in the banks so they didn't collapse Instability of system Defined reason: crash of housing market Moral hazard- employees rewarded for highly successful short -term, high risk bets Leverage- investments on credits climbed to unprecedented levels (imprudent mortgage lending). As lending standards decline leverage increases Distress sale of assets- further reduced asset prices and weaken confidence Predatory lending- gave out low standards loans to people that couldn't afford it Housing bubble- mortgage backed securities were bundled with safe and risky loans (CDOS) and approved as AAA Shadow banks- unregulated deregulation. Cause of Great Depression: stock market crash (credit crunch), policy failures (lack of intervention led to widespread loss of confidence), thousands of bank failures (bank runs) and extreme to deflation from the hoarding of money. Cause of Great Recession: deregulation (Greenspan laissez faire free market policy), predatory lending (no reqs. to get a loan), shadow banking system which was unregulated (ie. hedge funds) crisis of negative expectations (banks risky competition w/shadow banks) and moral hazard (fed gov would bail out banks/FDIC insurance). Use of New derivative instruments to evade regulation Causes of Both: asset price bubbles (Housing and Speculative bubbles in GD, Housing in GR), distressed sale of assets, widely available cheap money/credit, high leverage and risk taking.
According to Reinhart and Rogoff, what are the various forms by which governments can and have defaulted on domestic debt? 8 points-2 elements
High/unanticipated inflation. Financial repression via rate ceilings and limits on available instruments
How did the result get magnified and why? 6 points - 6 elements
Housing bubble disrupted credit markets on a wide scale Leverage climbed to unprecedented levels Greenspan FED) was warned of imprudent mortgage lending but refused to regulate because his free market philosophy. Mortgage instruments were composed of widespread leveraging by financial institutions. Hedge funds were unregulated and used leverage to exploit mispricing assets (CDOs) for profit. Once CDOs were realized they weren't as much as they were valued at, lack of confidence led to collapse of financial system Shadow banking system had no banking safety net and was not regulated
Explain the implications of fragile equilibrium for the likelihood of sovereign default. 6 Points - 3 elements
If confidence decreases, debtors cannot borrow additional funds to help refinance. If lenders suspect a default, they will increase rates to cover the risk. A large increase in the interest rate faced by the gov due to the fear. It will fail to honor its debt. This can result in sovereign default, and often comes with inflation and a devaluation of currency. Even here, if there are many creditors, just one can prevent rescheduling of debt If the issue is liquidity, a loan to the government can work if the debtor is able and willing to pay. If the issue is insolvency, then a loan or a rescheduled payment will not help, only prolong the problem. It's often hard to tell the two apart and thus a loss of confidence can force a solvent sovereign to default
How did technological innovation help science advance? (2)
Improved innovations by mechanics allowed for new scientific experiments. Steam engine lead to laws of thermodynamics, Microscope,
How are defects in corporate governance supposed to have affected the goals of traders in US financial firms? 6 points - 2 elements
In US, some corporate managers not necessarily interested in needs of shareholders (especially in cases where dividends are not paid) More concerned with their own compensation (managerial capitalism); take on riskier investments to help themselves (moral hazard)
How would Acemoglu and and Robinson answer:Are we moving from a virtuous circle in which efforts by elites to aggrandize power are resisted to a vicious one that enriches and empowers a small minority? (2)
Income distribution, Gerrymandering, Net neutrality
What do economists mean by the "infant industry argument"? Explain the argument in detail. 9 points - 3 elements
Infant industries need protection in order to properly develop and be able to compete with the external market. Thus, when developing starting industries, tariffs are imposed as to decrease pressure from global markets. Once the industry develops, trade liberalization can ensue. The industry that was protected no longer needs protection as it is developed enough to compete with the global world. The infant industry argument requires either of the 2 conditions: Presence of externalities (External Economies of Scale) Industry development gains Scale economies+Imperfect capital markets Combination of one or both: Imperfect capital markets and learning or scale economies which generate high startup costs
Why did Britain gain more long-lasting economic benefit from it's foreign trade empire (3)
Iron and Coal, inputs to production Property rights Invested back into institutions to grow their society Politics separate from religion Inclusive economy Gains. Less Concentrated on crown, went to public goods and services (ie roads, industry, etc..) Property Rights. Clearly defined property rights. Inclusive political/economical institutions. Led to expansion of trade which increased social mobility, wealth accumulation, and created a high incentive for labor/progress Inflation. Low inflation Other World Dominating Navy. Britain is an island so hard to invade meaning less money on protecting (why navy was built, not army) Lots of iron, coal and wood.
16. Describe the Asian financial crisis of 1997/98. (30 points) Lecture 14 a. Where did it start and why did it start there? 4 points - 2 elements
It started in Thailand because Thai housing bubble burst as asset prices climbed too high (Lecture 14). Before the crash, foreign capital/currency rushed into the country to help finance the housing demand. This expanded the available credit of the country. But the banking system not developed (low reserves of foreign currency and Baht depreciates). As the Baht was tied to the dollar, as foreign investment left the country the economy began to suffer. Contaigian led to other S.E Asian countries also failing.
n light of the inherent difficulty of industry target selection, how can we explain the seeming success of Japanese industrial policy? 5 points - 1 element
Japanese decided to target heavy infant industries which meant they were going to be successful due to Japan's Slogan "Rich Nation, Strong Army" and their industrial policy. This slogan became a long term solution as once the heavy industries were strong enough to enter the market, Japan became a military and economic powerhouse.
What links do economists draw between Japan's system of corporate governance and distinctive goals of Japanese enterprise? (2)
Keiretsu and close ties between economic institutions facilitate growth Main bank is tied to all member banks so if one suffers, the others and the main bank help. This helps ensure growth and reduces the chance of keiretsu failing Japanese economy very dependent on exports Aided by protectionism (tariffs) Suppliers buy goods from Keiretsu Also encourages internal growth
How is the Japanese system of corporate governance different from that of the US? 12 points -6 elements
Keiretsu —answer to main bank Cross ownership of shares No Public Trading(of Shares unlike the majority of US companies) Employment guarantees : Incentives are not going to be in line with profit making Focuses on Maximum growth rather than profit No Dividend payment More highly leveraged than US firms
C. How and why do these policies work? 6 points-2 elements
Krugman suggests that policies which create expectations for future inflation will stimulate spending —as a the value of money will decline over time.This can be done showering the banks with cash. If the dollar will be worth less in the next year, people are more inclined to spend that dollar now than when their money is worth less. A key characteristic of a liquidity trap is the associated deflation which incentivises holding onto cash; hence creating inflation will avoid worsening of the economy. Expansionary fiscal policy, such as cutting taxes on income that will be spent quickly and increasing government spending, demonstrates to citizens that the government is confident enough to invest and expand the economy, which will increase individuals confidence in the market. The cutting of taxes will incentivize the spending of money while increased gov spending will increase incomes and create jobs: with the goal that consumers will be more willing to spend their surplus money.
Who failed and who survived? 2 points - 2 elements
Lehman Brothers allowed to failed → biggest bankruptcy in US history Bear Stearns (rescued by JP Morgan/Chase → bought for $2/share, bought Bear Stearns and headquarters for nearly a 5th of its estimated value) - but not its stockholders Fannie Mae/Freddie Mac also bailed out Merrill Lynch bought by Bank of America
Identify 3 sovereign debt defaulters and their situations. 12 points - 6 elements
Mexico during the Latin American Debt Crisis In early 80s, there was the OPEC oil shock. In response the OECD encouraged western banks to lend their surplus to Latin American countries to avoid a world wide recession. However, Mexico announced it couldn't repay all its promised debt and defaulted. Many other Latin American countries followed and a financial collapse across Latin American ensued. However many other countries avoided outright defaults as they were bailed out by western governments, yet to this day some countries have not repaid debts. Argentina 2002 For years before their default, Argentina had pegged the peso against the US dollar through a currency board. However, in the late 90s/early 2000s the exchange rate began to decline as foreign investment began to leave the country. Argentina had to let the peso float and the value of the peso fell to 30 cents per dollar. Ultimately negotiated settlement to pay their debt at 30 cents to a dollar as a form of partial default. Russia 1998 In the midst of the Asian crisis, Western banks stopped lending to Russia due to loss of world confidence. Russia, who relied heavily upon foreign borrowings to repay its debts and expand its economy, were forced to devalue their currency and defaulted on their debt.
19. Moral Hazard, bank lending and financial crisis (30 points) a. Explain moral hazard in your own words. 4 points - 2 elements
Moral Hazard is when a lack of consequences due to being insured causes opportunists to make riskier decisions (e.g not being as worried if home were destroyed because home insurance would reimburse you a certain amount)
How widespread were such "revolutionary" changes? (8 points)
Most industries, even after the technological advancement of the steam engine, textile spinning, or iron making were rather unaffected. In their particular industries though, they were very significant. It was difficult to integrate this technology into backwards countries. First happened in the UK, then expanded to US and Western Europe. Eastern Europe and Asia had significant resistance to changes out of fear of creative destruction. Countries with more inclusive institutions led to faster changes. Advancement in military forces adoption. Fear of industrialization upsetting the status quo, challenging hold on power 4 aspects: First in UK, then to US and western Europe; difficult in Asia and Eastern Europe because of institutional resistance; industrialize faster if with inclusive institutions; military modernization forces adoption
According to Joel Mokyr, how did scientific advance help in a general way with technological innovation? (3)
New base of knowledge. innovation increased efficiency, development of new tools allowed for new experiments, positive feedback loop
Why is there a trilemma? 12 points - 4 elements
Only have ⅔ at the same time —never have all 3 in full at the same time "If we want to push global economic integration much further, we have to give up either the nation state or mass politics. If we want to maintain and deepen democracy, we have to choose between the nation state and international economic integration. And if we want to keep the nation state, we have to choose between democracy and international economic integration." Each country has its own institutional heritage and must adopt ⅔ that are in alignment with their cultural goals. For example a country desires to be a globalized nation state, they are forced into "golden straightjacket" which limits democratic choice. Thus, there can be only one of the three and every nation cannot be forced down one Anglo-American capitalist path. A push for more globalization will weaken democracy unless accompanied by new institutions for democratic global governance. If a nation chooses economic integration and a nation state they put on a golden straightjacket. If a nation chooses a Nation State and democracy the result is a Bretton Woods compromise. If a nation chooses democracy and economic integration the result is Global Federalism.
How does Gregory Clark support his contention that property rights were secure in Britain long before 1688 (3)
Records showing stability of land prices, rents, and returns suggest secure property rights. Farmlard was an asset with little risk concluded from low variation in above mentioned things. Also meant strong institutions to regulate and control property rights.
What are actions to avoid Sovereign Default? 8 points -4 elements
Refinance domestic debt through restructuring spending, reducing borrowing etc... Borrow/lend short term to maintain discipline (repayment) via crises— Short term rates are always much lower Other nations lend to potential defaulter (borrow from IMF/World Bank) Government approves more borrowing (raise debt ceiling) Raise taxes/generate more revenue to pay off debt.
What are some possible reasons for banks to take big risks? 4 points - 2 elements
Riskier lending/borrowing meant higher returns (profits) If bank close to insolvency or failing, will make risky investments regardless (if they dont they fail, so will try to stay alive through high profit motives, ie risky invests)
What does Paul Krugman mean by the phrase "shadow banking system"? 9 points-3 elements
Shadow Banks are non-traditional (non-depository) institutions that operate like banks, yet outside the regulation of banks and insurance companies (similar to trusts 'bank like institutions' that arose before the Great Depression) Have very little liquid capital, making them vulnerable to bank runs. Not required to maintain reserves/insurance. These institutions include hedge funds, money market funds and structured investment vehicles.
What dangers were there in the recent growth of a shadow banking system outside the scope of US banking regulation? 9 points-3 elements
Shadow banks were not required to hold liquid reserves, maintain substantial capital or pay into the deposit insurance system. Thus, investors could received higher interest rates on their deposits and issuers paid lower interest rates than long term banks loans at their own expense. These securities were short term liabilities which weren't backed by the banking safety net so if investors attempted to withdraw their money — "a bank run" —they would lose their whole investment. No agency to support bank runs No regulation to require reserves and maintain capital High risk investment without an insurance system (investors/funds could lose all their money) This also pushed real banks to engage in more risky banking practices to close the competitive edge.
What changes in European military technology favored centralized political power? 6 points-2 elements
Since the political climate had changed (nation vs nation, not lord vs lord), centralization of power was key to survival. Creation of standing armies, invention of gunpowder (used in cannons and muskets) advances in navy etc... all resulted from competition among states and the centralization of political power.
b. What countries were involved and what was the resolution for each country? 12 points - 12 elements
South Korea, Malaysia, Indonesia, Thailand. Contagion also to Russia, Brazil, and US Hedge Fund LTCM. As Thailand began to fall, contagion struck the surrounding nations and investors began a self fulfilling panic. Because of this loss of confidence, IMF had to intervene in order to save the S.E Asian economies. Yet the intervention was arguably to harsh as the IMF demanded high interest rates and stringent guidelines which some argue deepened S.E asian countries recessions. This lack of confidence spread all over the world and caused Russia to default on its debt: Russian devalued its currency and Western countries stopped providing loans. The effect of the Russian crisis also caused US. hedge funds to collapse. But thanks to Federal Reserve actions, staved off a huge crisis through lowering interest rates. Brazil was forced to devalue the real and got bailed out by IMF. Contagion spread as far as Argentina (who ultimately fell into a recession also).
According to Economic Historians why did economic benefits that Spain reaped from the new world prove short-lived? (3)
Spain had an extractive economy. All the bands went to the crown. They didn't reinvest into their society. They sold a wool monopoly which affected property rights. Also they extracted gold and silver instead of inputs to production. surplus concentrated in the crown, focus on war and consumption; extractive institution, no clear property rights; rely on domestic population as slave labor, no surplus, no incentive; gold and silver from conquered lands, not helpful for long term
What was the impact of the stress tests for big US banks on credit market conditions and why did the stress tests have this effect? 9 points - 3 elements
Stress tests were conducted to judge health of existing banks since banks has stopped lending to each other because no one knew who was solvent/insolvent. In the crisis of 2008, even if a bank was insolvent they were given a loan as to hide which banks were solvent and which were insolvent. This helped normalize the credit market as it avoided hysteria from the public if their bank was deemed insolvent. Ultimately the stress tests reassured depositors that the government would no longer let banks fail. Stress tests avoided a worsening of the recession by stabilizing and expanding the credit market. 3 main points: Stress tests and Fed provision of liquidity staved off meltdown. Stress tests provided more transparency and forced weaker banks to raise more equity. Stress tests also carried an implication that the government would not let any more big banks. fail
What were economically the most important innovations of that time period (Industrial Rev) (4)
The Steam Engine and the Chronometer. (Steam Engine helped increase productivity in the factories and helped the mining efforts while the Chronometer helped people measure Longitude better than what the Quadrant could do at the time.) Advances in textile, cotton manufacturing. Textile spinning. Using water wheel to power these processes. Then they began using the steam engine. Advances in coal mining and iron manufacturing (From Section) Transportation, iron making, steam power, mechanism of textile and factory development.
What was the impact on the British growth rate of aggregate income per head? Explain. (4 points)
There was a general increase on the British growth rate of aggregate income per head, though this time was different versus technological advance at other periods because the population growth exceeded the rate of technological advancement. Early revolution adaptation of automation had little impact on average wage in Britain. But later the aggregate income increased greatly. At the beginning of the industrial revolution people were still focused on agriculture so there wasn't an immediate impact on the growth rate of aggregate income. The transition from agriculture to factory jobs was slow. But later it increased rapidly because labor left agriculture and there was a increase on the British growth rate of aggregate income per head. 2 aspects: Beginning, little impact; later increase rapidly because labor leave agriculture
13. For what reasons do some historians term the changes that occurred in Britain during the late eighteenth and early nineteenth centuries an "industrial revolution"? What notable changes occurred in this period? (6 points)
There were significant changes in technological advancement, and a sustained increase in the rate of growth of output per capita, as well as significant societal and cultural changes. There was a positive relationship between population growth and living standards due to technological advancement. The economics became mechanized in the productivity of goods. Technological growth expanded rapidly due to abundance. The focus on the economy shifted from agriculture to artisans. (production of food to production of goods). Escape of the Malthusian trap. 3 aspects: Production more automated; a lot technological growth, innovations; shift from agriculture to artisan production Important idea - It become more "machines" versus labor, the new technology sped up production and streamlined the process. Things were now more automatic instead of manual and they had all these machines to do stuff. Production process became automatic-important
Who led the resolution and how? 10 points - 2 elements
US Treasury and FED Leads resolution, bailing out banks and insurance companies through particular programs (HERA, TARP, TAF, TSLF). Supplied cheap cash to banks TARP pumps banks with money and TSLF buys back the mortgage instruments (CDOs) as collateral to stop distressed sales. Quantitative easing policy 2008-2013, stimulus packages, bank bailouts Obama Era admin → Dodd-Frank Act → increases protection for consumers Stress Tests
Concretely, how did scientific understanding help with some of the specific innovations enumerated above (3)
Understanding of condensation and vacuum led to steam engine. New techniques such as puddling and rolling in iron manufacturing, due to a better understanding of metallurgy led to superior iron products.
d. What was the biggest potential risk and what happened? 10 points - 2 elements
Vulnerability of investor contagion (self fulfilling prophecy) stemming from loss of confidence due to moral hazard (crony capitalism —belief that government would bail out companies closely tied). Deregulation was rampant in Asian economies making them vulnerable to financial collapse. As crony firms invested in high risk assets (speculative housing market) a bubble began to form in the housing market. When it burst, the government could not bail out all the companies and the result was the financial crisis. This loss of confidence spread throughout S.E asian but other countries as well.
20. Policy trilemma. (30 points) a. What is a policy trilemma? 5 points - 4 elements
When a government must choose to have only two of the three following: -Independent monetary policy -Free capital mobility -Fixed exchange rates **only two of these three can exist at the same time —never have 3 at once in full
A. What do economists mean by the term "liquidity trap"? 6 points-2 elements
When investors only want to hold the safest assets, even if safe interest rates are zero. This represents a lack of confidence and/or a lack of incentives in the market and stalls economics growth. Characterized by low interest rates and high savings rates, which makes monetary policy ineffective (already low interest rate). Injection of money fails to stimulate the economy.
How would Acemoglu and and Robinson answer: Are America's best days behind it? (2)
Yes, rising gap between rich and poor, recent financial crash bc of Moral Hazard
b. Why is there a trilemma? 5 points - 1 elements
You can only have ⅔. You can never have all 3 at once. If a government wants free capital mobility and independent monetary policy, it must give up fixed exchange rates. If a country wants indp. Policy and fixed exchange rates, it must limit capital mobility through capital controls. If a country wants free capital mobility and fixed exchange rates, it must give up indp monetary policy as it has given its economy to the global market and utilizing independent policy can have disastrous consequences on currency.
