Financial and economic crisis

According to the Oxford dictionaries, a crisis is a circumstance or period of extreme hardship or risk. In general, a financial crisis occurs when the supply of money is insufficient to meet the demand. Yet, in business terminology, a financial crisis is described as a circumstance in which financial assets suddenly lose their value. In a real-world scenario, if a bank is experiencing an economic crisis, most of its customers will rush to remove all of their cash from the bank. As a result, in order to improve its liquidity, a bank will have to sell assets such as investments. The economic crisis is a condition or a situation brought by financial turmoil whereby an economy of a country faces downtown. In most cases a state facing this mess will probably have a falling Gross Domestic Product (GDP), this is a situation whereby there is a dry up of liquidity (current assets do not meet the obligations, current liabilities) and the rise or fall of prices (Knoop 2015). The increase in prices is due to inflation while the decline of rate is due to deflation. GDP is the total output produce of people and companies within a particular country for a specified period either quarterly or yearly.

This paper will deal with the causes, effects and final on how to overcome the financial and economic crisis.

Causes of financial and economic crisis in banking industry

1) Leverage

This is a situation where the bank borrows loans from the central bank to operate or run its activities and operations. In most cases one finds that there is no transparent accounting for these investments or leverage, therefore, making it hard for legislators to write into law and regulators to manage it effectively efficiently. The solution to this cause is radically putting high capital requirements and accepting their consequences which are slightly less harmful compared to the effects of financial crisis.

2) Liquidity

This is a situation where the current assets cannot meet the obligations of the firm, its current liabilities. In this case, lending long and borrowing short which takes us back to leverage as discussed above. The standard ratio of liquidity is 2:1, current assets to current liabilities respectively. The firms should aim to maintain this rate to solve the problem of cash (IMF 2009a)

3) Economy of scale

A firm may benefit from operating on a large scale. However, too big companies may experience some wastage of resources without the business realizing it such as mass production which may lead to some product being wasted due to small market available. This may result in increasing the prices of the product to meet the cost of production causing inflation. The solution to this is immense diversity, decentralization, and maintenance of excess buffers.

4) Conflict of interest

There is no profession allows the conflict of interests whatsoever. The only solution to this cause is forcing a particular firm in the industry to choose and stick on one business and customer type to serve. This will improve the system resiliency as there is increased the diversity of firms.

5) Taxes and subsidies

Tax policies usually control the flow of cash in the economy and cost of production. In the presence of subsidies in the marketplace, there will be low cost in the output in the industry; this will result in low prices. In the process, inflation will be controlled automatically. Also, there should tax policies such financial transaction tax that will discourage short terms speculation and thus encourage long-term investment.

6) Governance

Dictatorial governance in any organization can bring many crises such as financial and economic crisis. The only solution to this is that group should practice democratic governance, with this the opinions and interest of everyone in the organization will be heard and met accordingly.

Effects of financial and economic crisis

1. Effects on output

A country which experiences financial and economic crisis, its gross domestic product (GDP) will fall.

2. Unemployment

There will be increased unemployment in the country, as most firms will retrench employees to reduce the cost of production.

Overcoming financial and economic crisis

A country to overcome this crisis first it has to understand the different types of inflation and deflation, and how to control them through this they would have managed the predicaments in which it might be facing in that particular period.

Types of inflation

1. Demand-pull inflation

This is a situation whereby the aggregate demand is higher compared to total supply. This happens when the economy grows quickly and eventually starts overheating.

2. Cost-push inflation

This occurs when there is a rise in the price. This type of inflation can further subdivide into;

Creeping inflation

This is when the prices increase by 3 percent. This kind inflation rises demand of products as the consumers anticipate the costs of products to continue growing, thus making their purchases now. It also encourages the development of the economy.

Walking inflation

The inflation is between 3 to 10 percent a year. The economy grows too fast compared to its limited resources, thus ending up to be harmful. The people in that particular country start buying more than what they need to avoid the future higher prices. This, as a result, drives the demand for the products even higher, to a level that the supplies cannot keep with it. Finally, the inflation makes the price of products and services are priced out of reach of most people.

Galloping inflation

This is a situation where the inflation rises to 10 percent or more. The inflation wreaks the economy ultimately. The money in that country loses value at a rapid rate that most business and employee income cannot keep up with the cost and prices of the products and prices. The economy becomes unstable, and in most cases, foreign investors avoid investing in such countries. The government should look for varies means to prevent galloping inflation at all cost.

Hyperinflation

This is a case where the prices rise more than 50 percent a month. It is a rare situation to happen. It comes into being when the government prints the money to pay for its spending. The consumers buy more now expecting inflation. This makes the demand to go out of control. The hoarding of goods creates shortages causing prices to increase further leading to hyperinflation.

3. Wage pull inflation

When firms increase the wages of its employees, the production cost also increases. They then tend to shift this value to the end users of the product who are in this case the consumers. They change this burden by raising the price of the products and services. Also due to the increase in the wages of the employee, it gives them higher disposable income, which will, in turn, result in increased consumption.

4. Imported inflation

This is a situation where the imports become more expensive due to depreciation in the exchange rate. To add on, the reduction also makes exports to be more competitive thus increasing its demand.

How to control inflation

When the country controls inflation, it would have overcome the economic crisis. The methods which can be used to control inflation in a country include;

1. Monetary policy

The government bank may but high the rate of interest hence making borrowing more expensive and saving more attractive. This will help in reducing the aggregate demand and also slow down on the consumer spending and investment. The high-interest rate also makes the exchange rates to be higher thus decreasing inflationary pressure by; making imports cheaper, reducing demand for export and increasing the incentive to exporters to lower cost (Brown 2010).

2. Fiscal policy

This is a situation where the government wants to reduce demand for products to reduce inflation. Tax can be added on VAT and income by the government and cut its spending. This will also improve the budget of the country.

3. Control of money supply

This means that controlling the amount of money will control the inflation.

4. Supply-side policies

The government should issue policies to increase competitiveness and efficiency of the economy of its country thus putting down pressure on long-term costs.

5. Wage control

The government should allow growth of wages to an absolute limit. This will reduce consumer spending and cost of production.

Conclusion

As discussed above for one to overcome the financial and economic crisis, they must control inflation and deflation in that country using the policies discussed above such monetary, fiscal systems and others.

References

Brown Gordon. Beyond the crush; “Overcoming the International of the First Financial and Economic crisis.” 2010

IMF; ”The effects of International Economic crisis for middle and low income up countries.” Washington DC. March 2009.

http://www.imf.org/exeternal/np/sec/pr/2009/pr0953.htm

Knoop Todd A. Business Cycle Economics: ”Understanding Recessions and Depressions from Boom to Bust.” 2015.