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Economics: Financial Crises

The financial crises which occurred in 2008 led to a recession and the growth rates fell tremendously. This had major effects not only in America but also in other countries, which resulted in a fall in the Gross Domestic Product (GDP) and increased unemployment rates that had never been reached before in certain countries. The more economic developed countries (MEDC’s) such as America had greater effects compared to the less economic developed countries (LEDC’s).

The European crises which started in 2011 has also led to similar effects however there are important differences between these two crises which occurred. The European government therefore needs to use the fiscal and monetary policies to try and resolve this crisis. According to Thomas, Hennessey, and Holtz-Eakin (2011: 1), the United States crisis was first and foremost caused by government intervention in the housing market. Many subsidies were given and the banks of America allowed many people to purchase these houses on credit due to the high prices of houses.

The low interest rates at the time however, increased the amount of mortgages that were given by the bank as consumers took advantage of this opportunity. The banks however also took this opportunity to borrow a large

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amount of money to issue mortgages. When the bank’s target group (‘prime mortgages’) was fulfilled, they had to find new markets and therefore started giving these bonds to ‘subprime mortgages’. This market group had low credit rating and the individuals could not however pay their debts and were eventually written off.

Due to the supply of houses being greater than the demand of houses, the prices had to drop in order to sell these houses. The value of houses therefore dropped and house owners therefore lost a lot of money as they had purchased them for more when the prices were very high. The banks had therefore also lost money because they did not gain any returns from rent or interest which meant that they could not pay back the lenders. (Thomas et al, 2011: 1). This caused the financial crises.

On the other hand the Euro crises was triggered when certain countries including Italy, France, and Germany did not stick to their limit of borrowing which was supposed to be to a maximum of 3 percent. (BBC News, 2011). Spain and Italy also face a major ‘competitive price disadvantage’ as wage rates have been constantly increasing while countries such as Germany agreed upon keeping their wage rates steady. This means Italy and Spain will not export as much as Germany due to the higher prices that people are not willing to pay for.

Due to the current government debt that they are already facing in these countries the lack of exports will not help their situation as there is less money in the country that could be spent on consumption, investment, and government expenditure. A big question for governments now is whether to cut spending or not. Cutting spending will mean that wage rates will decrease as firms will not have the finance to maintain the high wage rates as there is less money in the economy, therefore debts will become an even bigger problem as these workers will not be able to repay their debts. (BBC News, 2011).

If governments do not cut spending then there is a ‘risk of financial collapse’. (BBC News, 2011). Greece also plays a crucial role in the European crises as it had borrowed millions of Euros from many different countries due to the low interest rates that they never had before they were allowed to join the European Union. (The Telegraph, 2010). All these factors above have led to major unemployment rates and falls in economic growth. It has also led to factors which are making the problem worse such as strikes in Greece due to employees not being paid enough money with a rise in the price levels.

Many countries including South Africa have been affected by these two crises that have occurred which will still spill onto other countries. In 2008-2009 the recession had led to high unemployment rates ( 24. 5%) and a fall in South Africa’s GDP which had dropped to -6. 4%. (Global Economic Recession, 2008). The economy was therefore contracting and also had major effects on certain industries such as manufacturing. The European crisis has also resulted in negative factors for South Africa.

This is because the demand from the EU countries for South African products has decreased due to people’s savings increasing to pay out their debts. European Student Think Tank, 2011). South Africa will also experience a major decline in exports into these EU countries due to less money in their economy. Importing goods from the EU will be much more expensive as they will be trying to obtain as much revenue as they can. Due to the EU being the second biggest investor in South Africa, investment will continually decrease and less money will be available which will also lead to multiplier effects such as less consumption expenditure in the country. (European Student Think Tank, 2011).

South Africa will be able to use the Intermediate-Run Growth Model as a means to try growing the economy and as an action to recover from these crises. The introduction of new technology or an increase in the level of education will increase the supply side and more goods and services will be introduced. (Froyen, 2009: 396). If demand is unchanged then the price levels will decrease and this may lead to more exports for South Africa as other countries will take advantage of the cheaper products. This will also create more jobs for the public and may reduce the problem of high unemployment rates.

The low interest rates should be maintained as this will lead to higher investment which will generate more money into the economy. (Froyen, 2009: 396). A decrease in the tax rates will lead to more Saving and Investement as shown in the diagram below. Adapted: Froyen, 2011: 399 A decrease in the tax rate will mean that people will have more money available to spend in the economy or save and earn an interest on money that they would have never had if the tax rates had not been cut. (Froyen, 2011: 399).

A decrease in the after-tax real wage in the classical system will increase labour in South Africa because the opportunity cost of not working when these tax reductions have been made is high as they will be foregoing more income. (Froyen, 2011: 400). This again will help decrease the unemployment rate. Government regulation should also be decreased for this period of time as this will decrease capital formation and increase the production costs which will cause the supply curve to shift to the left and increase inflation rates. This is what caused the slowdown of the labour productivity in the 1970’s. Froyen, 2011: 395).

The Keynesians however believe that in the intermediate run the demand side is also very important as a means to grow the economy. (Froyen, 2011: 402). They believe that output is important for investment, and that capital does indeed contribute to growth in the economy, and see ‘investment demand more important than saving supply’. (Froyen, 2009: 403) Different growth models may have different assumptions about different theories however they may all be important to try and offset the negative impacts that have affected the South African economy.

Monetary and fiscal policies will always be very important to help the economy recover however excess use of either one may make situations worse for South Africa. Focusing on certain models such as the classical model may also be a problem because some assumptions are not actually true in the real world such as the economy always being at full employment. In the short run the government may also have an important decision to make as there is a trade off between unemployment and inflation. (Froyen, 2009: 220).

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