Question

In: Economics

Describe two ways that financial market instability may lead to adverse effects on real economic activity....

Describe two ways that financial market instability may lead to adverse effects on real economic activity. How does Keynes’ view compare to Classical Economists view of financial market instability.

Solutions

Expert Solution

The two ways where financial markets instability may lead to adverse effects on economic activity are:

- An optimal and well developed financial system that comprises of direct market and indirect bank based finance as well as developed legal system will favor a better allocation of resources thereby leading to economic growth. If the financial system does not grow and boost the economic system also will be at a standstill.

- If the financial markets are not stable this may affect the reallocation of capital which would in turn affect the restructuring of the economy.

- A lack of well developed stock market, lack of innovative high technology firms would hamper in maintaining a country's long term growth potential. The stability of financial markets is thus required to maintain the competition in an economy.

2) Keynesian economist believe the Economy is best controlled through the financial stability of markets that further manipulates the demand, the classical economist do not deny this fact but yet believe that it takes a great amount of time for the economic market to adjust to any monetary or financial influence. Keynesian economist believe that short term problems in the economy should be immediately dealt with whereas the classical economist concentrate mostly on the long term as they believe that financial instability in short term is only a road block currently and will be resolved in the longer run by itself.


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