Question

Financial Instability and Lender of Last Resort

1. Discuss the Minsky’s financial instability hypothesis. Why and how does financial crisis arise?

2. According to the Keynes-Minsky theory, discuss the role of the central bank in times of financial crisis.

Answer 1

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector the "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments.

The financial crisis of any country can have the following reasons.Which are as follows.

*When the price performance of a country's financial institutions falls very rapidly. Because of this, their value in the stock market falls due to which people start withdrawing money from the stock market there.Which leads to instability in the stock market.

*Also because of the non-functioning of the industrial sector.Due to which the industrial sector increases the demand for loans from banks, which leads twin balance sheet problem.

Instability comes in the economy due to the crash of the stock market and increasing financial crisis of banks.

To overcome the financial crisis, various types of banking roforms are given by the Central Bank such as merging banks, merging banks and infusing money in banking sector, adopting expansionary monetary policy etc.

It can be said that according to the rule of all major keynes, by increasing the demand and creating demand to follow the demand supply rule in the market.