Economics 11 Report: Financial Crisis and Economic Impact

This economics report provides an in-depth analysis of the global financial crisis of 2008, examining its origins in the US housing market, the subsequent credit crunch, and the resulting international recession. It explores the role of bank rates, particularly in Australia and New Zealand, as a monetary policy tool to combat recession, and the effects of expansionary monetary policies. Furthermore, the report investigates the economic relationship between Australia and China, highlighting China's significant influence on Australia's trade, investment, and overall economic growth. The report assesses the ways in which China's economic fluctuations impact Australian businesses and the broader economy, including the effects of China's slowing growth and its implications for trade and investment flows.

Running Head: ECONOMICS
Economics
Name of the Student
Name of the University
Author note

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Table of Contents
Answer 1..........................................................................................................................................2
Answer 2..........................................................................................................................................3
Answer 6..........................................................................................................................................7
References......................................................................................................................................10

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Answer 1
The Global Financial crisis that started from July 2007 had fully explored in 2008. The
main driving factor for the financial crisis was credit crunch happened in housing market. During
this time, the US investors lose their confidence. The US economy suffered with a liquidity crisis
as resulted from reduced value of sub-prime mortgages. To counter the crisis US government
injected a considerable amount of money in the financial sector. In September 2008, the crisis
took a disastrous form as the stock market crashed and high volatility is observed globally
(Treeck 2014). Not only investors but also the consumers lose their confidence and restrict their
choices.
The Global Financial Crisis originated in the US housing market. The homeowners in US
had withdrawn their subprime loans because it becomes difficult for them to repay the
mortgages. With declining price of houses, they find themselves in huge debt. There is large
number of loan defaulters that put banks and financial institution in trouble. The valuation of
land decreases as compared to the valuation when loans are given (Paulson 2013). Banks
suffered from a liquidity crisis. Following the housing bubble burst lending or receiving loan
became extremely difficult. The liquidity crisis in the economy is known as credit crunch.
United State is one of largest economy in the world. It maintains economic relation with
many other nations worldwide. The financial crisis in US spread internationally and countries
went through a recessionary crisis. There were foreign banks that bought US collateralized debt.
In times of financial crisis in part of these loans were transformed into collateral debt obligations.
The financial institutions across the world participated in the debt transactions. For example,
many European and British banks had exposed to the mortgage loans. With increasing loan

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defaulters in US theses banks suffered a huge money loss (Bekaert et al. 2014). The banking
system in US is connected internationally. In the phase of losing money banks limit their lending
to others. When banks restricted lending to each other there occurred a supply shortage of funds
and firms and consumers and firms find it difficult to lend money from banks. The reduced
supply of money was responsible for a declining aggregate demand (Helleiner 2014). As a result,
countries those were not directly related to subprime mortgages in US housing market suffered
from the crisis. US maintain a trade relation with many other countries. The recession in US
caused a fall in their import demand. This affected the export demand of nations and exporting
countries contracted with recession in US. The reduced volume of global trade makes the
financial crisis a global phenomenon. The crisis in financial sector reduced the confidence of
firms and consumers resulting in a global crisis. The global stock market was severely affected
by the financial crisis (Özmen and Yaşar 2016). Declining share price means lower wealth and
reduced confidence leads to lower growth.
The Global Financial Crisis in 2008 could have been prevented if Federal Reserve did not
ignore the early signs and take active steps at the beginning of the crisis. The lending indicators
first signaled trouble in November 2006. Then the commerce department reported a drop in
home permits by 28 percent. However, then Fed did not believe that housing price could fall. Fed
then remained optimistic and believed on the strength of domestic economy to counter housing
price slump (Godlewski 2014). If government intervenes at the early stage then U.S. and rest of
world could be saved from the crisis.
Answer 2
Bank rate is the interest rate that central bank charges to the commercial bank on
borrowed fund. The Bank rate in Australia and New Zealand is knows as official cash rate. This

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is an effective tool used by the central bank to control money supply in the economy. Banks and
financial institution are made for settling inter-bank transfer of funds and the transaction rate for
the cash are determined through buying and selling of bonds and government securities through
money market operation (Mian and Sufi 2015).
Recession is defined as a declining phase of economy characterized with a significant
downturn in all economic activity. During recession, the economic suffers from a decline in its
Gross domestic Product, slowdown of general price level or inflation, low wages of workers and
rise in the unemployment rate. When the declining phase continued for at least six months, it is
termed as recession. Persistent recession for one year or more put the economy in steady
depression (Cynamon and Fazzari 2015). Therefore, it is important for nations to combat
recession before taking the forms of depression.
The policy makers to revive the economy use expansionary fiscal and monetary policy.
The expansionary monetary policy aims at increasing the money supply. A reduction in the Bank
rate or Cash rate is the most effective tool to achieve this goal. When central bank reduces the
bank rate then it becomes easier for commercial banks to borrow money. With ease of
borrowing, the supply of loan able fund increases. The increased supply of funds reduces the
interest rate that investors have to pay for borrowed money from the commercial banks (Juselius
et al. 2016). Therefore, a decrease in cash rate encourages investors to borrow more funds. The
productive investment increases output and expands demand. There is another channel for
interest rate to affect the aggregate demand. The lower interest rate discourages household for
saving and increase their consumption spending. This increases aggregate output. This can be
evaluated using the framework IS-LM.

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Figure 1: Effect of a reduction in cash rate
(Source: as created by Author)
The LM curve reflects the effect the monetary policy. When the central bank reduces
cash rate, the available money supply increases and it causes shift the LM curve rightward from
LM to LM1. Accordingly, interest rate in the economy reduces from r* to r1and output increases
from Y* to Y1.
This is how a reduction in the cash rate is supposed to increase the aggregate demand and output.
In order to achieve this goal and combat recession central all over the world uses the tool of cash
rate to fight recession in their economies.

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The Global Financial crisis originated in United State affect Australia and other major
economies worldwide. These countries suffer a recession and government there gave attention to
counteract economic downturn with unveiling fiscal and stimulatory packages. The Reserve
Bank of Australia Quickly responds to the recessionary crisis by cutting cash rates. Overnight
there was a cut in the official rate by 425 basis point and fall to the emergency level of 3%
(Bhutta and Keys 2016). By lowering the cash rate Australia escaped from the recession during
Global Financial Crisis that affects other OECD nations. With reduced cash rate, an
improvement in the trends of household demand is observed. This is associated with a strong
employment growth. For the last few years, RBA maintains the cash rate at the recorded low
level. However, the monetary policy stimulus affect the economy less than the Central Bank
actually expects. The RBA estimated cash rate to be at 3 percent, which is equal to its inflation
target of 2.5 percent plus real rate of 1 percent. However, since 2014 the consumer price inflation
in Australia has failed to reach to targeted level (Green 2016).
Following great recession many advanced nations adapted an expansionary monetary
policy. It was Central bank of Denmark that first implemented a negative interest rate. The
central banks of several European nations and bank of Japan followed the same. The low or
negative interest rate initially helped the economies to counter recession (Illes, Lombardi and
Mizen 2015). However, it comes along with a distortion in the financial market and raise the risk
of financial instability if funds are not used for productive investment.

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Answer 6
It is long sine Australia shares a good economic relation with China. China’s growth
manifests urbanization, manufacturing growth and infrastructure investment. This generates
demand for building materials, manufacturing raw materials and energy demand transport and
electricity. Australia was in well position to meet China’s growing demand and provide a ready
platform the manufactured goods produced in China. Since then an economic relation of mutual
dependence builds and develop gradually. China today is considered Australia’s one of the
largest trading partners making significant contribution both for export and import. Australia is
in position of sixth largest trade partners of China. Almost twenty five percent of manufactured
import of Australia imports from China and export 13% of thermal coal to China. The
dependency of Australia is not limited to its trading relation but also in terms of investment.
China is a major source of Australia’s foreign investment. China is the third largest investors of
Australia with making 3% of its total investment through channel of direct foreign investment.
China is keen in investing infrastructure projects in Australia (Sheng 2016).
The businesses in Australia are affected from economic fluctuation in China. During
China’s economic boom, the business gain significantly. However, recently China has shifted its
growth policy towards a more consumer-oriented economy. The reliance on consumerism makes
the economic growth in China slower. Many Australia’s business is expected to derive profit
from supplying their product to China. They are likely to suffer a loss from slowdown of China’s
economy.
China’s economy has severe impact on global economies but Australia is more exposed
to growth decline in China than others are. A major share of Australia’s export (Above 28
percent) goes to China. The expanded export market and China’s investment to Australia make

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the economy heavily dependent on China. The economic strength of China is one of the
important determinant factors of Australia’s economic growth (aph.gov.au 2017). There are
number of ways through which impact of China’s economy on Australia can be evaluated.
The slowing economy of China means a reduction of bilateral trade volume between
China and Australia. Australia mostly exports Coal, Copper, and Gold, Cotton and Nickel ores
and minerals. In the minerals category, Iron Ore dominates. However, Australia also export
agricultural product to China. With a declining growth in China, the export demand from
Australia declines. The sudden fall in the trade volume causes an oversupply of goods in
Australia. From the supply demand framework it is evident that an excess supply of goods lower
prices in the market. This is what Australia expects and cares for China’s economic situation
before taking economic decision. When domestic economy slows, then many investors in China
drive out their funds from Australia. China’s investors mostly invest in infrastructure projects in
Australia. If the funds are withdrawn then Australian economy will hugely suffer. The tourism
industry is likely to be affected when tourists from China reduce their spending.
During Global Financial Crisis, China helps Australia a lot and prevents the economy
from sinking. China’s demand of minerals provides support to Australia and maintains economic
stability of Australia (www.smh.com.au 2017). However, China protects Australia in times of
Global Financial crisis; it is believed that China’s money raises the property price in eastern
region.
From 2000 to 2014, the average annual growth rate in China is recorded as 9.75%. The
growth rate slows down from beginning of the present decade. In 2011 growth rate was 9.5%
followed by a growth rate of 7.8 percent in 2012, 7.7 in the next year and 6.9% in 2015. The
slow down resulted from the shifted attention from investment led growth and dependence on

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consumption based growth. The growth rate is predicted to be even slower in the next years. The
poor condition of infrastructure and industries in China have affected many Asian economies
including Australia. The declining growth rate in China, outflow of Capital and action of
People’s Bank of China for hedging fund together contribute to a contraction of China’s
economy (abc.net.au 2017). This creates uncertainty for the Australian economy. The financial
crisis in China has spillover effects on other region and negatively affects commodity prices of
any important goods in Australia.
Australia mostly exports mineral resources such as iron ore, gold, copper, nickel and
other resources. As the China’s economy contracted the demand for mineral resources from
China also shrinks. Australian mining sector is most vulnerable to China’s economic slowdown.

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References
Aph.gov.au. (2017). Australia’s economic relationships with China – Parliament of Australia.
[online] Available at: https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/
Parliamentary_Library/pubs/BriefingBook44p/China [Accessed 21 Nov. 2017].
Bekaert, G., Ehrmann, M., Fratzscher, M. and Mehl, A., 2014. The global crisis and equity
market contagion. The Journal of Finance, 69(6), pp.2597-2649.
Bhutta, N. and Keys, B.J., 2016. Interest rates and equity extraction during the housing
boom. The American Economic Review, 106(7), pp.1742-1774.
Cynamon, B.Z. and Fazzari, S.M., 2015. Inequality, the Great Recession and slow
recovery. Cambridge Journal of Economics, 40(2), pp.373-399.
Godlewski, C.J., 2014. Bank loans and borrower value during the global financial crisis:
Empirical evidence from France. Journal of International Financial Markets, Institutions and
Money, 28, pp.100-130.
Green, J., 2016. Australia. In Angels without Borders: Trends and Policies Shaping Angel
Investment Worldwide (pp. 163-175).
Helleiner, E., 2014. The status quo crisis: Global financial governance after the 2008 meltdown.
Oxford University Press.
Illes, A., Lombardi, M.J. and Mizen, P., 2015. Why did bank lending rates diverge from policy
rates after the financial crisis?.
Juselius, M., Borio, C.E., Disyatat, P. and Drehmann, M., 2016. Monetary policy, the financial
cycle and ultralow interest rates.

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Mian, A. and Sufi, A., 2015. House of debt: How they (and you) caused the Great Recession,
and how we can prevent it from happening again. University of Chicago Press.
Mulligan, M. (2017). Reserve Bank of Australia cuts official cash rate to record low 2% at May
meeting. [online] The Sydney Morning Herald. Available at:
http://www.smh.com.au/business/the-economy/reserve-bank-of-australia-cuts-official-cash-rate-
to-record-low-2-at-may-meeting-20150505-ggueak.html [Accessed 21 Nov. 2017].
Özmen, E. and Yaşar, Ö.D., 2016. Emerging market sovereign bond spreads, credit ratings and
global financial crisis. Economic Modelling, 59, pp.93-101.
Paulson, H.M., 2013. On the Brink: Inside the Race to Stop the Collapse of the Global Financial
System--With Original New Material on the Five Year Anniversary of the Financial Crisis.
Business Plus.
Radio National. (2017). The Australian economy and the low interest rate future. [online]
Available at: http://www.abc.net.au/radionational/programs/rearvision/the-australian-economy-
and-the-low-interest-rate-future/6248462 [Accessed 21 Nov. 2017].
Sheng, Y., 2016. Economic Growth in China and Its Potential Impact on Australia-China
Bilateral Trade (No. 25642).
Treeck, T., 2014. Did inequality cause the US financial crisis?. Journal of Economic
Surveys, 28(3), pp.421-448.