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CHAPTER 1 ECONOMIC CRISES, NEOCLASSIC VIEWS, Finance types (Minsky 1978),…
CHAPTER 1
ECONOMIC CRISES
GROSS DOMESTIC PRODUCT
(measured as) Total income (or)
adding up all household income
(via country tax authority - i.e HMRC)
(measured as) Total expenditure
Estimate total spending on domestically produced goods/services
(via sales data, surveys - e.g office of national statistics)
(measured as) Total output (or)
the value added by firms in producing their good/service
(via regular surveys of production)
Positive GDP growth rate = economic growth :deciduous_tree:
Negative growth rate = contracting economy. 2 or more consecutive quarters = recession :warning:
Used as an indicator to asses overall economic strength
:check: guides policy decisions
:red_cross: does not measure income distribution
:red_cross: does not measure wellbeing
:red_cross: does not measure unpaid work such as caregiving
:check:considers government spending
:check:considers net exports
:check:considers consumption
:check: considers investment
:red_cross: does not measure undesirable side effects such as pollution
INFLATION AND DEFLATION
a measure of how prices change over time
percentage change = ((CPI in current period - CPI in earlier period) / CPI in earlier period) * 100
CPI (consumer price index) = a weighted average of the price of a basket of goods / services (eg bread, apples, electricity)
can affect living standards
pensioners, self employed profits, welfare recipients may not receive income adjustments in line with inflation
important to overall economic activity - high levels of inflation = lower GDP growth and employment levels
workers - real wage needs to rise in line with inflation
CLIMATE CHANGE
Factors of production - Land
Failed crops
shortages
higher prices
Factors of production - Labour
uninhabitable land = migration
Cost of severe weather events
redirection of resources
WHY DO THEY HAPPEN?
THE KEYNESIAN REVOLUTION
argues against the ability of economies to self-recover
Keynes solution to high unemployment was for governments to inject spending into the circular flow of income
Jump start economy
Increase output
Increase employment
Increase consumption
:warning: stagflation emerged in 1970s
ECONOMIC FRAGILITY
existence of risk and uncertainty - no perfect information
existence of decisions to invest for future gain - no immediate profit maximisation
Minsky's financial instability hypothesis (1978, 1922)
Increasing Instability
as stability persists, lenders become more confident and see opportunity for higher profits
:warning: more projects funded with speculative finance. Ponzi finance also grows.
Crisis
enthusiasm evaporates, the cost of borrowing increases or there is doubt that profits will materialise.
Ponzi finance loans become worthless :arrow_right: further falls in asset pricing
lending reduces (credit crunch)
profits slump, interest payments on speculative loans cannot be met
speculative finance :arrow_forward: ponzi finance, hedge finance :arrow_forward: speculative finance. The economy is in crisis
Stability
:check:Prudently financed, modest profit expectations
during stable economic growth, most investment is funded with hedge finance.
when crisis occurs, policy intervention should replace the finance available - e.g Global Financial Crisis, 2008
EXTERNAL SHOCKS
Neoclassical views
In the event of crises, the economy should be left to self-recover
fluctuations in economic activity are temporary adjustments
all crises are due to exogenous shocks
WHY DOES IT MATTER?
GDP <>= Output <>= income / spending
Output falls, less labour needed = more unemployment
Poverty >
Living standards <
loss of psychological and social benefits
self-esteem
companionship
unemployment rate = number of unemployed people as a percentage of the labour force.
:check: indicator of wasted labour
:check: indicator of economic and social injustice
GDP DEFLATOR
A means to measure inflation alongside CPI
Current prices - nominal GDP
Output valued at prices prevailing at the time
A change between periods therefore shows change in both output volume and the price the output is sold for
Constant prices - real GDP
Output valued using prices for a specified base year
A change between periods therefore only reflects changes in output volume
NEOCLASSIC VIEWS
individuals make rational choices to maximise utility
Markets tend towards equilibrium through supply and demand interactions
Firms aim to maximise profits
Finance types (Minsky 1978)
Hedge
future income from the project is expected to meet the agreed debt repayments in every time period.
agents have a cautious approach to income projections
Speculative
Expected income is enough to cover debt interest in the short term
Future income is expected to be enough to meet the total debt repayments eventually, but not in the immediate future.
borrower manages debt only by periodically borrowing more money or selling assets to meet the repayments
Ponzi
expected income in the immediate future is not enough to cover the debt interest.
Assumes the value of the asset will increase over time, enabling the debt to be repaid.
borrower manages debt only by periodically borrowing more money or selling assets to meet the repayments
(CIRCULAR FLOW OF INCOME MODEL)