Question

How would each of the following scenarios likely affect (that is, exacerbate (that is, make a bad situation worse) or mitigate (that is, make it less painful or severe) the occurrence of a financial crisis (explain briefly):

Fearing potential contagious effects, the IMF suggests that it stands ready to bailout a country which may face a financial crisis.

b. The threat of an eventual intervention by the IMF demanding that the country that is about to face a financial crisis should adopt strict adjustment regime (such as the expenditure-switching and expenditure reduction policies.)

c. The Basel Committee on Banking Supervision relaxing its bank capital adequacy requirements so that each bank could create enough liquidity into the system which in turn may stimulate the economy.

d. A country facing financial crisis imposing capital controls. (Note: capital controls are measures taken by a government, central bank or other regulatory body to limit the flow of foreign capital in and out of the domestic economy.

e. As a result of its unsustainable budget deficit, national and external debts, Greece’s credit rating plummeted. As a result, international financial investors began to look if other EU members were facing similar problems and/or have weak financial institutions and regulatory systems.

Answer 1

b. a threat of IMF intervention can be very effective because with IMF intervention many terms and condotions need to be followed the country's government which can hinder their freedom to operate as they please. also IMF intervention is also a negetive sign to the investors, thus an economy facing IMF interventions may see a decline in investment. so a threat of IMF intervention unless an economy adopts changes in its expenditure can mitigate a financial crisis.

c. an economy already facing financial crisis should maintain capital adequacy so that they can absorb the losses that the economy is facing. banking system is the backbone of the economy and capital adequacy which is determined by capital asset ratio is a requsite for banks effective operation. at the time of financial crisis maintaining customer confidence is essential and for that capital adequacy is impotant so even if relaxing banks capital adequacy requirements may stimulate liquidity in the economy but this would exacerbate the financial crisis sitution.

d. free capital mobility brings might bring rapid economic gain but it also entails significant risks. during the the of financial crisis it is benificial to implement capital controls to maintain currency value, inflation amd brings economic stability. all these factors are essential to contol during an financial crisis. so capital contols can mitigate financial crisis by undervaluing currency to make a country more desirable for exports, which in turn can instigate recovery from the crisis.

e. it is a natural reaction of the financial investors to look into the economies of other EU members post the greece financial crisis. but this would negetively impact the crisis situation because if investment goes down due lack of confidence in the investors, the crisis sitution would worsen. large investment can recover crisis situations but if investments go down coming out of the crisis would be very difficult.