FINANICAL CRISIS

Financial Crisis

Financial Crisis

Introduction

The financial crisis that started in 2007 had a deep affect on the financial markets all over the world. The money markets contracted a great deal resulting to cause severe disruption in the short-term funding of the banks

The financial crisis starting in August 2007 deeply affected financial markets around the world. In particular, money markets contracted substantially leading to severe disruptions in banks' short-term funding. There was a massive rise in the unsecured money market rates to unprecedented levels reflecting banks' reassessment of borrower's creditworthiness and their willingness and capacity to lend. This all resulted in great deal of inflation in prices globally for goods and services

Monetary policy effectiveness in the current financial crisis

The world is currently dealing with economic inflation. To understand the working of monetary policy in controlling inflation we need to understand the concept of inflation and price stability.

To achieve price stability the reserve banks use the monetary policies. Price stability refers to the stable monetary state in which the price neither rises nor falls rapidly. The policy target agreement (PTA) is an agreement between the Reserve Bank governor and the Minister of Finance to keep the percentage of inflation between 1% - 3%. This is done to ensure price stability and to influence prices in the economy.

The role of money

In the time of bartering people use to exchange goods and service to make the trade. Money was invented in order to solve the problems that occurred due to the barter system. Money gives people the ease to buy the products and o to save it and use for later expenditures. Money needs to have a specific value or worth just like there are other standards, as to measure weight time or length. As whatever good you will purchase you have to pay an equaling amount of money for that. When there is price stability the prices remain balanced in the form of, when the price of few materials will raise the price for others will fall.

The rate of inflation increases when the demand for goods and services are higher than the supply of the available goods and services. On the other hand if the rate of production is greater than the demand of the goods and services than there is a deflation in the market.

Reserve Bank control of inflation and avoid deflation

As discussed earlier inflation is the increase in demand as compared to the supply of the goods and services. This gap between the economy's capacity to supply and the demand for the goods and services is known as the output gap. The monetary policy has the ability to dampen or stimulate the demand, which is done by the adjustment in short-term interest rates (Kohn, 2009). The reserve bank makes sure that the inflation remains in between one to three percent inflation band.

Reserve Bank influence on short-term interest rates

Usually the Reserve Banks influences short-term interest rates, which include the interest rate of floating mortgage, by adjusting the Official Cash ...