Central banks seem unlikely to allow the money supply to fall by one fourth It

Central banks seem unlikely to allow the money supply

This preview shows page 9 - 11 out of 13 pages.

9 / 13
ECO209Y1Y Macroeconomics Textbook & Slides Notes Lecture 12, Chapter 11 from recurring Case Study: The Financial Crisis and Economic Downturn of 2008 and 2009 : Beginning with low interest rates : less expensive mortgage, Americans can buy higher priced homes, easier for subprime borrowers to get mortgages substantial boom in US housing market, drove up housing demand , doubled price between 1995-2006 Securitization : a financial institution (a mortgage originator) makes loans and then bundles them together into a variety of investment instruments called mortgage- backed securities . These mortgage-backed securities are then sold to other institutions (banks or insurance companies), which may not fully appreciate the risks they are taking Then unsustainable housing price : housing price fell by 20% from 2006-2008 1. Mortgage defaults and home foreclosures : these homeowners were underwater : they owed more on their mortgages than their homes were worth. Many of these homeowners stopped paying their loans. banks repossess the houses in foreclosure procedures and then selling them, more sales, lower prices 2 . Large losses at the various financial institutions that owned mortgage-backed securities : by borrowing large sums to buy high-risk mortgages, these companies had bet that housing prices would keep rising; when this bet turned bad, they found themselves at or near the point of bankruptcy, banks stopped trusting one another and avoided interbank lending the ability of the financial system to make loans even to creditworthy customers was impaired 3 . Substantial rise in stock market volatility : financial system less able to perform its normal operations, the profitability of many companies was called into question, hard to know how bad things would get stock market volatility reached levels not seen since the 1930s 4 . Decline in consumer confidence : households started putting off spending plans, expenditures for durable goods in particular plummeted As a result of all these events, the economy experienced a large contractionary shift in the IS curve US Government Response : 1 . Fed cut its target for the federal funds rate from 5.25 percent in September 2007 to almost zero in December 2008 2. Treasury put billion funds into the banking system, and the banks could use these funds to make loans. In exchange for the funds, the U.S. government became a part owner of these banks, at least temporarily. The goal of the rescue (or “ bailout ,” as it was sometimes called) was to stem the financial crisis on Wall Street and prevent it from causing a depression on every other street in America 3. Major increase in government spending to expand aggregate demand Why Canada didn't have significant financial crisis : 1. Canada has a

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture