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What are the causes and the consequences of recent global economic crisis?

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1. What are the causes and the consequences of recent global economic crisis?

Ellis (2009) addresses this topic at a conference on the implications of the global financial crisis, and some of his ideas are sketched below to consider for your paper.

Initially we heard about the 'sub-prime crisis? then later 'financial turmoil? and is now it is referred to as the Global Financial Crisis. Indeed, many financial systems around the world have been under extraordinary strain recently. The macroeconomic and human consequences of that crisis are also presenting the effects. Questions arose, such as: What caused this global financial crisis? What have been the consequences, both for the global economy and the financial system itself?

Causes of the Global Economic Crisis

Ellis (2009) proposed several causes of the financial crisis including: the misperception and mismanagement of risk; the level of interest rates; and the regulation of the financial system. Expanding on these:

1. FIRST, it could be argued that the primary underlying driver of the crisis was the inherent cycle of human psychology around risk perceptions. When times are good, perceptions of risk diminish. People start to convince themselves that the good times will go on forever. Then, when the cycle turns, risk aversion increases again, often far beyond normal levels, let alone those seen during the boom.

2. LIKEWISE, investors?perception of risk changed in the years leading up to the crisis. Yields on emerging market bonds or US companies at the riskier end of the spectrum all narrowed relative to those on US government bonds and other securities that are seen as very safe. More recently, those spreads have widened out dramatically, as investors became more risk-averse, and the 'search for yield?turned into a 'flight to safety?

3. The effects of this boom-bust cycle of psychology are heightened when investors use leverage. Borrowing to purchase assets is lucrative when asset prices are raising, because all the upside beyond the interest costs goes to the investor, not the lender. But when times are bad and asset valuations are falling, investors?losses are magnified by leverage.

4. SECOND, alongside the perceptions of lower risk was the low level of interest rates in the early part of this decade. At the short end, policy interest rates in the major economies reached levels that were unusually low compared with history. At the longer end, bond yields in the major economies were also unusually low over this period. This remained the case, even once policy rates started to rise in 2004. At the time, the low level of long rates was considered somewhat puzzling ?a 'conundrum? as former Fed chairman Greenspan put it. Over time, though, many observers have come to the view that unusually strong investor demand had pushed long rates down. Among those investors were central banks and other government agencies in emerging and industrialised economies, which were accumulating foreign reserves.

5. Many observers were concerned about the way the low level of interest rates made higher leverage so attractive. Inflation pressures were quite subdued at that time, so the macroeconomic situation didn't necessarily warrant much higher interest rates. There has been plenty of debate, inside and outside central banks, on whether monetary policy should also respond to financial stability concerns. But there is also recognition in many quarters that low interest rates were not ?and shouldn't be ?enough to cause such a crisis on their own.

6. THIRD, a lack of appropriate financial regulation in some countries is widely regarded as one of the important causes of the crisis. Many shortcomings have been identified in this area. These include: the capital requirements on complex financial products such as collateralised debt obligations (CDOs); the use of ratings provided by the private-sector rating ...

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