Question

Why study the financial system and financial markets?

Explain the ‘crowding-out’ hypothesis. Explain the ‘crowding-in’ hypothesis. Discuss the problems with deflation

Answer 1

Why study the financial system and financial markets?

Answer: We should study financial system to understand the overall financial system of the country. We can understand the "Generally accepted accounting principles" (GAAP) on the basis of which, financial reporting is done. By studying the financial system, we will get to know the governing bodies like FASB, SEC etc.

By studying financial markets, we will understand the different financial markets, i.e. Stock market, commodity market, currency market, forward and futures market. We will get to know about various financial products and instruments, i.e. shares, bonds, mutual funds, ETFs, options, futures, swaps, currencies etc.

‘Crowding-out’ hypothesis- When increased interest rates decrease the investment in private sector, it is called Crowding out hypothesis. Sometimes Government spends more on economy, society and infrastructure, this activity leads to higher interest rates and this further leads to lower private sector investment.

‘Crowding-in’ hypothesis- When private investment increases, this situation is called  Crowding-In. It happens because of Government spending increases.

Deflation- It is an economic situation where supply of money decreases and purchasing power of money increases. Prices of commodities come down. To control this situation and to keep the price stable, Government increases supply of money in the country and prints more currency notes.