Question

1.) Explain why and how the government intervenes in the financial system, and the problems the government safety net creates.

Answer 1

Financial systems make smoother the fund flow from lenders to borrowers. Government interventions in the financial system are in existence in a number of countries from early 1990s. Disapproval against financial suppression and low performance of public banks, changed the trend against government intervention. Consequently, in 1990's, introduction of financial sector reforms in developing countries arises with the objective to improve the allocative efficiency of the financial institutions as well as financial markets. Anyway, recently the global financial crisis leads to an increase in interest where governments can play well in the financial sector. The main reasons for government intervention are:

• To correct market failures.
• To achieve more equitable distribution of income and wealth.
• To improve the performance of the economy.

The government fight against market inequities through regulation, taxation, and subsidies. Governments will also intervene in markets to promote general economic fairness. Governments intervenes the markets to promote other goals such as national unity and advancement.

Government safety net gives a safety net to individuals and families to protect them from poverty. Banking crisis is the major problem caused by this safety net. Severe economic downturns occurs due to this.