Week 12 Handout

PS 140 Handout for Week 12 Week of November 18th, 2024 Lectures 19 & 20 Textbook 9.25-9.4; Funke, Payne and Applebaum, & Mims Key terms and concepts Bretton Woods system • Definition: • Example & other details: World Bank • Definition: • Example & other details: International Monetary Fund (IMF) • Definition: • Example & other details: Special Drawing Right (SDR) • Definition: • Example & other details: Balance of Payments • Definition: • Example & other details: Austerity Measures • Definition: • Example & other details: Keynesian economics • Definition: • Example & other details: Fiscal Policy • Definition: • Example & other details: Monetary Policy • Definition: • Example & other details: National Debt • Definition: • Example & other details: Multinational Corporation (MNC) • Definition: • Example & other details: Foreign Direct Investment • Definition: • Example & other details: Host Country • Definition: • Example & other details: Home Country • Definition: • Example & other details: Discussion 1. What is the pattern of financial crises? What are the two theories used to explain financial crises? How do these apply to and explain the Global Financial Crisis? Financial crises typically follow a cycle involving rapid expansion of credit, a bubble phase, followed by a sharp contraction, leading to economic instability. The two main theories explaining financial crises are the “credit boom-bust theory,” which focuses on excessive lending leading to bubbles, and the “financial fragility hypothesis,” emphasizing vulnerabilities within the financial system. The 2008 Global Financial Crisis illustrated both theories, as unsustainable mortgage lending led to a massive bubble in housing prices, which burst, causing widespread financial instability. The combination of systemic banking failures and inadequate risk assessments deepened the crisis’s impact. Process: • Financial globalization leads to massive overborrowing and overlending • Countries and banks accumulate large debt burdens and have trouble paying them • Threat of default on loans (scares lenders and investors) • Banks fail • Countries pushed into economic crisis or severe debt • Governments turn to IMF for assistance • IMF lends in exchange for unpopular economic policy reform 2. Why didn’t the Global Financial Crisis turn into a Great Depression 2.0? What do Funke, Schularick, and Trebisch find in their study about the political effects of financial crises, and how did we see these results played out in the Global Financial Crisis? The Global Financial Crisis did not turn into a second Great Depression because of quick and coordinated policy responses, including monetary stimulus, fiscal expansion, and financial sector bailouts. Funke, Schularick, and Trebisch found that financial crises often lead to political instability, with significant gains for far-right parties, more fragmented parliaments, and increased street protests. In the aftermath of 2008, Europe experienced this pattern as mainstream parties struggled, and anti-establishment movements gained momentum. The strong policy interventions helped stabilize economies, but political fallout was still evident. 3. The IMF’s Special Drawing Rights (SDRs) are a world currency used only by governments for international currency management and national accounts. Do you think SDRs could become a currency used by businesses and individuals, and how could this happen (or why couldn’t it)? What would be the effects on world business and on the ability of sovereign states to manage their own economies? Special Drawing Rights (SDRs) are used primarily between governments and international institutions, making their use by businesses or individuals unlikely without significant reform. If SDRs became a more broadly accepted currency, it could enhance global liquidity and reduce exchange rate risks for businesses. However, it would challenge the ability of nations to manage domestic economic policies independently, as a globally adopted SDR would reduce the dominance of national currencies like the U.S. dollar. A shift towards SDRs might create a more stable global financial environment but with implications for national sovereignty. 4. Many scholars and politicians alike think private international investment is the best hope for the economies of Russia and Eastern Europe. Given the current economic and political disarray in that region, what kinds of investors from the industrialized West might be willing to invest there? What actions could the governments of Western states take to encourage such investment? What pitfalls would the governments and investors have to watch out for? Investors willing to engage in high-risk environments might see opportunities in Russia and Eastern Europe due to the potential for significant returns as the region stabilizes. Western governments could encourage investment by offering political risk insurance, providing tax incentives, or establishing investment treaties to protect foreign capital. However, political instability, corruption, and uncertain regulatory environments are critical pitfalls that both investors and governments must consider to avoid losses or disputes.