Question

4) What happens to the value of the dollar if the European Central Bank (ECB) tightens its money supply and raises interest rates? How will this impact the value of the dollar, exports and imports, AD and GDP?

5) What are 5 financial innovations and deregulations that led to the financial crisis in 2008? What are 5 policy responses by the Federal Reserve and the U.S. Government and Treasury department that helped us to get out of the financial crisis? Who are the winners and losers?

Answer 1

4. The increases in interest rates and tightening of the supply will make Euro more attractive and will lead to appreciation of the currency in respect to dollars. It will attract the foreign investors as well. So in such a case euro will again against Dollars and the imports will become cheaper where as the exports will become comparatively less attractive. The GDP tends to grow in nominal terms more than in real terms. It is a good scenario right? No, if not monitored then it can lead to inflation as the supply will be way less than the demand and the economy might shrink.

5.Financial innovations means finding new instruments to invest in and meet the client requirements of beating the market and attracting further investments, some notable innovations were -

1. Special Purpose Vehicles were created for securitization

2. the adjustable-rate mortgage.

3. mortgage-backed securities (MBS) or collateralized debt obligations (CDO) were bad mortgage classes were combined together,

4. credit default swaps (CDS) mostly by the insurance companies.

5. Asset backed commercial conduits

Some deregulations, which cause financial crisis of 2008 are -

1. Failure on the part of credit rating agencies when they gave high ratings to junk assets

2. Michael Burry literally handed over the list of potential defaulters when he asked the banks to create the special CDS. yet the banks didn't react.

3. Regulatory board failures.

4. Too much liquidity with no controls on the lending

5. Failure to see that how overpriced the assets were

Five responses against financial crisis of 2008 -

1. Amendments in the Federal Deposit Insurance Corporation (FDIC) bank resolution mechanism to accommodate NBFC

2. Introducing Term Auction Facility to provide short-term loans (liquidity) to banks and making them "too big to fail".

3. Bills passed to regulate lending.

4. Some firms like lehman brothers that were higher levered were allowed to fail, even Merrill Linch was saved by Bank of America and not by the government ;

5. More regulatory checks for banks and insurance companies;

top management in banks were the winners till the bubbles burst; taxpayers can said to be the losers as their money was used to bailout the banks but the real winners were the holders of the CDS.