Financial crisis occurs when the value of assets or financial institutions falls dramatically. It is often related to the investors that withdraw their money or sell off assets from their saving accounts as they expect that the value of the assets will drop in the future if those assets or money are being remained in the financial institution.
There are four types of financial crisis. Firstly is bank crisis. It occurs when the investors suddenly withdraw their capital or deposits from the bank in fear that insolvent will occur. Such situation will cause bankruptcy to bank since further withdrawals are done by investors and bank could not recover their short term liabilities. Secondly is global financial crisis. When there is a sudden speculative attack, the currency of a country will be devalued because the investors dump the currency when they expect that the exchange rate will drop. It will results in the loss of the liquid assets or foreign currency of the central bank. Therefore, the currency collapses. Thirdly is sudden stop in capital flow. It occurs when there is a sudden slowdown or discruption in the supply of external financing firms. When firm borrows in advance to pay for the inputs, the sudden stop in capital flow would result in the drop in aggregate demand and lead to a decrease in output. Lastly is wider economic crisis. Recession occurs where GDP shows negative growth for a period of time. If the situation is prolonged, depression occurs (Claessens, 2013).
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One of the factors that cause financial crisis to happen is the expansion of the mortgage lending by individuals. The huge increase in mortgage lending has increased the debts of households. When there is a boom in house sales price, households have to pay high monthly payments and it leads to the soar in mortgage deliquencies. Thus, the mortgage value drops. It would lead to the decrease in lending mortgage by households and investors would slow down the economic growth. Besides, leverage contributed to financial crisis too. When people borrow money to invest, they have the potential to earn more money from the investment but also have the high risks to face bankrupcty. Once people face bankrupcty, it will lead to the fail in payments to others and therefore create financial problems indirectly that link from one to another. The occurrence of financial crisis in one country like United States would have huge effects on economic activities which causes a huge drop in the aggregrate output. Thus, there will be large drops in investment, consumption, production, employment and exports and imports (Claessens, 2013).
Economic issue- Global Financial crisis that impact China
The United States subprime crisis that occurred in 2007 has entered into a global financial crisis after the Lehman Brothers bankruptcy in 2008. Economists considered it to be the worst financial crisis since the Great Depression that occurred in 1930. The global crisis has caused world-wide economic downturn and subsequently hit the China’s economy very badly. The global financial crisis occured has caused China’s GDP to decrease from 13% in 2007 to 6.8% in the fourth quarter of 2008. The industrial production sector growth rate of China has dropped doubled when compared to previous period while many others product sector growth rate has dropped to negative percentage (Yongding, 2010).
The fall in the GDP on the fourth quarter of 2008 is due to the rapid fall of the export sector. This is because the major export markets like Hong Kong, Korea and Taiwan have all slipped into recession due to global financial crisis while China is the country that very dependent on net exports to boost its economic growth. In 2007, China’s net exports have contributed over 20% of GDP growth (Ming, 2009). However, due to the impact of global financial crisis, the export of China has slowed down significantly because of the weakening of external demand. China as a labour-intensive sector exports great number of unskilled workers from rural areas to other countries. The sudden collapse of export market has caused many export-led private companies in China to close down and result in about 20 million of unskilled workers lossed their jobs (Ming, 2009). Due to this, the unemployment of China has increased. The number of unemployed workers has increased from 12.51 million in the third quarter of 2008 to 21.71 million in third quarters of 2009 (Huijian, n.d). Since many unskilled workers came from rural area with lower education background, they faced the problem of poverty when being laid-offs.
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To stabilize the economic growth, government of China has implemented expansionary fiscal policy. In 2008, government has implemented a US$588 billion investment plan for 2009 and 2010. It is one of the world-wide biggest fiscal rescue plans. The plan concerned on increasing the whole output expenditures and cutting taxes. The budget focuses mainly on investing in the infrastructure of China and taxes rebate for exports (Yongding, 2010). At the same time, China Central Bank (PboC) also released loosening expansionary monetary policy to increase the bank lending by reducing the reserve ratio from 17.5% to 13.5%. The interest rate for loan has been cut down to boost consumer’s spending and borrowing. This has result in the increased in bank loan by 1.62 billion (yuan) in January 2009 (Ming, 2009).
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