Theories on Causes of Financial Crisis

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Table of Contents

Introduction
Causes
Effects
Recommendations
Conclusion

Introduction

Financial crisis is a term used to refer to a situation in which the value for money goes up hence attracting high demand. This in return increases its supply. It entails unstable financial markets in which the currency flow is limited and hence affects households and businesses. In other words, the demand and supply of goods and services is disrupted. Many economists have developed theories on causes of financial crisis and how it can be avoided.

Causes

Mortgage lending is one factor associated with financial crisis. This is because earlier on the institutions dealing with the mortgages did so at low interest rates for high priced houses. In addition, the conditions involved were favorable to many people. This led to many people taking this mortgage loans yet they could not afford.

A financial system shock disrupted the situation and the prices of the houses fell and many people could not pay their loans. The institutions therefore experienced liquidity issues. This caused such business to be risky and not many people could invest in them.

There are those factors that are not related to subprime mortgage market but have contributed immensely on the financial crisis. They include small banks, agents providing loan security, investment procedures by the government and other financial institutions lending and proving securities for the same.

Effects

Financial crisis has led to collapse of many businesses, high rate of unemployment hence poverty as well as reduction in government revenues. Moreover, slow economic growth characterized by decreasing stock market and weak currency. Most of the economies have continued to decline and financial institutions have continued to suffer. For this reason, there is limitation on the circulation of currency. Moreover, the interest rate on the loans from the banks has increased.

It has also resulted to many economies especially those that are developing to seek help from financial institutions such as World Bank and International Monetary Fund (IMF). In addition, their policies and conditions put in place by these institutions are harsh and thus continue to weaken these economies.

Financial crisis has an impact on the business in that it hinders export of goods and services hence increasing the demand for them. The high demand and low supply on the other hand affects trade because it decreases purchasing power for many people.

Recommendations

Financial crisis can be averted using various tools. For example the governments should control such a situation by decreasing interest rates. This can be achieved by directing the currency back into the banking system. This would ensure that market liquidity is supported and at the same time encourage currency flow.

Mitigation measures should also include reviewing policies in order to reduce the negative impacts on the economies. Favorable policies should be implemented so as to correct the situation. For example trade policies ought to change and regulations be revisited. The policy and the regulations should be based on the accurate information about market. In addition, financial institutions should be funded in order to act as security during crisis.

Conclusion

Financial crisis is characterized by unstable markets. It can occur in any economy and when it does, numerous effects are felt. Financial crisis can be caused by various activities in the economy. Many economies therefore try at all cost to prevent it. They do so by regulating the interest rates on the loans and increasing the purchasing power of the people. The demand and supply of goods and services is also controlled.

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Theories on Causes of Financial Crisis

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