Question

Global monetary policy during the credit crisis of 2008

Answer 1

The global crisis of 2008 arose in the USA due to sub-prime market lending, that is, credit was being given to one and all without proper interrogation about whether the loan amount could be revived by the bank or not. This happened in the real estate sector and a bubble was created - and as soon as the foreign investors realised this, they started pulling out money in huge amounts outside America causing the financial crisis. This then spread to other economies of the world, theeir currencies being firmly connected to the dollar ($).

This crisis resulted in a negative invetment environment. It has caused a decrease in liquidity in the market, and an overall decrease in the supply of credit. The reason for this can be traced back to the eroded confidence due to the financial crisis. Let us make a deeper understanding of what the crisis was and why did it occur.

Sub-prime market lending: There was an increase in credit being provided - it was being provided to those who did not qualify for it. This resulted in an increase in the demand for real estate, driving its price exponentially high. The banks, on the expectation of a further increase in prices kept lending money to those who asked for it. Simultaneously, many builders focussed on promoting their projects. Eventually, there was such an increase in supply of real estate (over building) that real estate prices started falling sharply. This resulted in the increased lending rates of banks. The subprime borrowers were unable to repay the banks (at the increased lending rates) and hence the overall health of the banking sector dipped - the foreign investors took money out of banks because banks could not repay them...sharply causing the financial crisis.

America is one of the most trade active countries in the world. All those currencies who were heavily dependent for imports and/or exports on America bore the wrath of the crisis. A meticulous approach has been adopted by almost all countries after this crisis, measures have been employed to completely eliminate subprime lending. There is decreased availability of credit because of stricter restrictions on who can borrow money and who cannot.

Therefore, the monetary policy regime has shifted from an expansionary to if not a contractionary, a stable one.