Poverty, Financial Crisis, and ERM: A Political Economy Analysis

This essay delves into critical economic issues through a political economy lens. It assesses whether poverty is attributable to inequality rather than scarcity, analyzing implications for both neoclassical and political economy approaches, highlighting issues like unequal income distribution and endowment effects. It also evaluates the adequacy of neoclassical economics in explaining the 2007/8 Great Financial Crisis (GFC), citing excessive risk-taking, rising borrowing, regulatory errors, and the UK housing market decline as key factors. Finally, the essay elucidates the 'Impossible Trinity' and its relevance to the UK's failure in the European Exchange Rate Mechanism (ERM), referencing the Black Wednesday event and its economic and political consequences. Desklib provides access to more solved assignments for students.

Political Economy

Table of Contents
1. Poverty in today's world is not due to scarcity but to inequality'. Assess the implications of
this view for neoclassical and political economy approaches.....................................................3
2. Does neoclassical economics provide an adequate explanation of why the 'Great Financial
Crisis' (GFC) of 2007/8 happened? ............................................................................................3
3. Explain what is meant by the 'Impossible Trinity' and why it is relevant to the failure of the
UK's membership of the European Exchange Rate Mechanism (ERM)....................................4
REFERENCES................................................................................................................................6

1. Poverty in today's world is not due to scarcity but to inequality'. Assess the implications of this
view for neoclassical and political economy approaches.
As per the Neoclassical theory, it is stated that economy must be run in such as manner
where the employment must be increases by which income level of the consumer can be
enhanced as they are getting proper pay of their work and they are become eligible to purchased
goods quality or premium products but the purchasing of the consumer can not be the same as
the income level of the individual as they also keep their income as a part of savings as well. All
these cycle gradually increases the overall sales of the firms. There are various implications of
this theory which are given below:
This is stated that business firms are not giving the equal income to every people which is
becoming the main reason of the poverty as per this theory. For example, in same organisation
employees are not equally for who are having similar set of skills and also working on same
designation. Thus, with the help of this example, it is proved that poverty in today's world is due
to the inequality in the business environment.
Other implication is the endowment effects, in which it is stated that there are certain
negotiable instrument followed by the company to endorsee the consumer or the employees with
the right of further negotiation. It is also expressed in the words that rich people are getting more
rich and poor are remaining poor due to the unequal distribution of the income and the resources
in the society.
2. Does neoclassical economics provide an adequate explanation of why the 'Great Financial
Crisis' (GFC) of 2007/8 happened?
Neoclassical theory says that the consumer would consume only that amount at which
they are earning or having. The solution to this theory is the Keynesian perspective that suppose
decrease in the aggregate demand leads to cause the overall economy and this will go in
recession with high degree of unemployment. This response to use the government policy to
maintain the aggregate demand which also eliminates the overall recession gap in the economy.
This also says that government policy have given some sort of ability which recognize the
particular situation and then adjust the particular demand respectively. There are main causes of
great financial crises are given below:

 Excessive risk-taking in a favourable external environment: This is due to the
competition increasing among the leader and the extend the huge amount of housing
loans & due to the good economic development environment seeing to be highly
profitable at such time.
 Rising borrowing by banks & investors: banks & other investors abroad take amount
to enhsnce their lending & purchase MBS commodities. Borrowing money to buy the
assets is called as the leverage which is considered as the potential loses and results when
the house prices began to fall, the investors incurring huge looses.
 Regulatory & policy errors: There was adverse regulation of the institution which
created & sold the inappropriate MBS to investors. Fraud was increasingly which
includes the inappropiate income of the borrower & promising investors on the safety of
the MBS goods which were being sold.
 UK house prices fell and borrowers misses repayments: Increasing number of
borrowers unable to repay their amount of loan and the house prices in country peaked in
the year of 2006 and the same with the rapidly increasing supply of the given newly built
homes or building in some part of the nation. These are the practices which are the
sensitive to house prices in the nation due the proportion in the households with more
debts had risen a lot during the boom.
3. Explain what is meant by the 'Impossible Trinity' and why it is relevant to the failure in the
membership of the European Exchange Rate Mechanism (ERM).
Impossible Trinity is defined that a nation cannot have a fixed exchange rate, free
movement of capital & an independent monetary policy at the same time. This occurs due to the
lower interest rates over last year and they are ahead the protect the pound of the nation by
sucking liquidity out of the systems which implied in increasing cost of money and higher rate of
interest.
There was the incident called as the Black Wednesday occurred on 16 September 1992 as
when the government of UK was forces to withdraw the pound sterling from the European
Exchange Rate Mechanism and this is due to the failure to keep the pound above the lower
currency exchange limit which is fixed by the ERM. In that time the overall cost estimated by

UK Treasury of Black Wednesday at £3.14 billion. Treasury paper analysed that when the
government had gained $24 billion of currency reserve and the amount of pound fallen by the
same amount so that UK could made a £2.4 billion. Five year later, the ruling conservative
party suffered the landside defeat & did not return the power until 2010.
Thus, when the UK is not able to maintain the given interest rate or the needed capital
then they are forced to take out their currency in European Exchange Rate Mechanism (ERM)
and this implied due to the Impossible Trinity which says that open capital, fixed capital and
independent monetary policy can not be maintain at the same time in the market which also
implied in having the rising of the particular problem which is leading to have inappropriate flow
of capital and interest rate within the UK economy.

REFERENCES
Books and Journals
Neoclassical Growth Model, 2021[Online] Available
through<https://corporatefinanceinstitute.com/resources/knowledge/economics/theories-
of-growth/>
What is impossible trinity, 2013 [Online] Available
through<https://www.livemint.com/Money/BmZSKXM8bGdUkIGRMK4DLJ/Deja
rgoned-Impossible-trinity.html>
The Global Financial Crisis, 2021[Online] Available
through<https://www.rba.gov.au/education/resources/explainers/the-global-financial-
crisis.html>
Exchange Rate Mechanism (ERM) Definition,2021
<https://www.investopedia.com/terms/e/exchange-rate-mechanism.asp>