Question

When the financial system is functioning well, the economy benefits (and when the financial system is functioning poorly, the economy suffers). Discuss the importance of a well-functioning financial system to employment and economic growth in an economy.

Answer 1

A well-functioning financial system directs funds in a way that it can be most efficiently used, promoting employment and economic growth. The significant of a well-functioning financial system for economic stability in long-run can be observed following the collapse of several financial institutions across the Europe and America which ultimately resulted to the financial crisis at the global level. The inaccessibility of credit at the time indicated that the firms were unable to gather the sufficient funds and as a result the economy suffered

A well-functioning financial system causes a rise in both the demand of loanable funds and the supply for loanable funds in three ways. Firstly it decreases the transaction costs for making financial deals incurred by either borrowers or lenders. Secondly, it shrinks the associated risk with engaging in investment spending or making investments. Thirdly increasing the liquidity for the financial assets, it makes the purchasing and saving of financial assets more lucrative to potential lenders, and thus increasing the investment spending.

Well-functioning financial systems would be characterized by financial instruments that can be used to solve financial concerns, financial disclosures to be done timely resulting in market prices that depicts the available information (efficient information), liquid markets with the reduced cost of trading (operationally efficient) and thus prices that primarily move with changes in fundamental value rather than the liquidity demands. It promotes wealth with the efficient capital allocation for the decisions.