Topic 7 : Finance and the real economy Flashcards
What is the Policy Trilemma ?
The policy trilemma, also known as the impossible or inconsistent trinity, says a country must choose between free capital mobility, exchange-rate management and monetary autonomy (the three corners of the triangle in the diagram). Only two of the three are possible.
What is the Minsky Hypothesis ?
Financial instability hypothesis examining how long stretches of prosperity sow the seeds of the next crisis. In a nutshell → Economic stability breeds instability. Periods of prosperity give way to financial fragility.
What is a ‘Minsky Moment’ ?
Describes a situation when debt levels reach breaking-point and asset prices across the board start plunging.
What is Hedge Financing ?
This is the safest type of financing.
Generally occurs soon after a crisis when banks and borrowers are cautious. Loans are made in modest amounts and the borrower can afford to repay both the initial principal and the interest.
What is Speculative Financing ?
As confidence rises banks begin to make loans in which the borrower can only afford to pay the interest. Usually this loan is against an asset which is rising in value. This should be manageable as long as the economy functions smoothly, but a downturn could cause distress.
What is Ponzi Financing ?
Is the most dangerous
When the previous crisis is a distant memory, we reach the final stage - Ponzi finance. At this point banks make loans to firms and households that can afford to pay neither the interest nor the principal. Again this is underpinned by a belief that asset prices will rise.
Which type(s) of financing indicates a more stable economy ?
Economies dominated by hedge financing, that is, those with strong cash flows and low debt levels - are the most stable.
Which type(s) of financing indicates a more unstable economy ?
When speculative and, especially, Ponzi financing come to the fore, financial systems are more vulnerable/unstable.
What are the common features of Irish & US credit crises ? (ICRM)
- Irrational exuberance
- Capital flow bonanza
- Regulatory imprudence
- Moral hazard
What is irrational exuberance ?
The behavioral anomaly of intermittent periods of aggregate over-confidence and over-optimism in security markets (Celtic Tiger era in Ireland, feeling of invincibility in the US market having speedily recovered from the dot.com bubble). Irrational exuberance, leading to over-inflated asset prices and excessive aggregate risk-taking, is a clear common feature of both the US and Irish crises.
What is capital flow bonanza ?
Refers to a sustained surge in capital inflows in the run-up period before the crisis. The US and Irish crises share the common feature of a capital flow bonanza in the periods prior to their credit crises.
What is regulatory imprudence ?
Policymakers and regulators allowing the risk profiles of their financial services sectors to evolve in very dangerous ways, influenced by strong domestic political pressures.
What is moral hazard ?
Occurs when an agent has an incentive to take economically inefficient actions because they are insulated from the risky consequences of of their behaviour.
What are some differences in Ireland’s experience of economic recovery post GFC and post Covid ?
- State of the economy prior to each crisis
- Speed of recovery
- Policy response from Gov + EU
- Nature of the shocks
What is the proximate cause of the boom and bust in Ireland ?
Construction
This construction boom led to an employment boom which drove wages in all sectors of the economy to uncompetitive levels; and generated the tax revenues that funded substantial rises in government spending.
