Great Depression - Free Essay Example

1. The financial crisis of 2007-2009 has been called the worst financial crisis since the one related to the Great Depression by leading economists. a) Discuss the main factors that have contributed to the crisis. (20 marks) The financial crisis was due to the bankruptcy of banks and extreme market volatility. One of the factors leading to the financial crisis was the growth of the housing bubble which happened in 2005 to 2006. Real house prices surged greatly, making residential real estate great and very safe investment. This housing bubble resulted in numerous homeowners refinancing their homes at lower interest rates. Therefore, it was very easy to borrow money, especially for purchasing a home. This caused the high default rates on subprime and adjustable rate mortgages (ARM) to increase quickly. Cheap and easy credit terms (low interest rates) and a long-term trend of rising housing prices encourage borrowing since the Federal Reserve slashed the interest rates to cope with recession and September 11 terrorist attacks. This affects consumption and investment to increase as people and firms will borrow more. Loans such as mortgages and credit cards were easy to obtain and consumers feel that they have the ability to repay within the stated credit period. Banks repackage the mort gages as mortgage-backed securities (MBS) and collateralized debt obligations (CDO) and these financial instruments greatly increased as borrowers want higher returns. There is also a lack of transparency and understanding by the investors. Thus, the risk in investing regular mortgage backed securities was considered low and it was sold to institutions and investors all around the world. In addition, investors invested more than they actually had capital for as they considered such securities low risk. This in turn contributed to the deflating of the housing bubble as asset prices move inversely to interest rates and it is risky to speculate in housing. USA housing and financial assets decreased in value after the housing bubble burst. Even so, many banks and firms still continued bundling the mortgages despite many of them had bad loans, and Wall Street kept buying and selling them to investors. Agencies that regulate the U.S. financial sector were also not paying attention. Besides easy credit conditions, both government and competitive pressures led to an increase in the amount of subprime lending. Major U.S. investment banks and government sponsored enterprises like Fannie Mae contributed in the expansion of higher-risk lending. Some banks and institutions were willing to lend money to homebuyers with poor credit. U.S. Securities and Exchange Commission (SEC) relaxes the net capital rule and this encouraged the largest five investment banks to increase their financial leverage and aggressively expand their issuance of mortgage-backed securities. Fannie Mae and Freddie Mac further expanded their riskier lending. The subprime lending increased United States homeownership rate significantly. Thus, rents decrease and house prices increase. The increase in housing prices stopped in 2006 and many subprime borrowers faced difficulties paying their mortgage and some was on the verge of bankruptcy. The losses in the subprime mortgage markets triggered u proar throughout the international financial system in mid 2007. Confidence in many financial institutions and stock market were also affected. When stockholders found out about the bad loans these firms were carrying, they withdraw their money immediately. The markets plummeted. Besides that, there was a lack in trust in banks and interbank lending was disrupted. Defaults and losses on other loan types also increased significantly as the crisis expanded to other parts of the economy. Demise of Bear Stearns happened in March. In July, IndyMac Bank went into receivership, but the worse of all was the bankruptcy of Lehman Brothers in September 2008. In conclusion, all this happened due to greed, lack of regulation and creative innovation in the financial industry. b) Assess the impact of the US financial crisis on the Singapore economy. (20 marks) Singapore was the first East Asian country to suffer a recession from the US financial crisis after July 2008. As Singapore is a small nation, we have to rely heavily on exports and almost 66 percent of its domestic production is exported. Singapores economy will hence be affected since its export partners are affected by economic crisis. The recession arises due to the reduction of non-oil exports in manufactured goods caused by the deterioration of economic conditions in the US and Europe. The slowdown is caused by the weak global demand for high technology equipments, an industry on which Singapore is heavily reliant. As a result, Singapore exports decline drastically. In the first quarter of 2009, trade fell by a sharp 24 per cent. Fluctuations in Singapores real GDP are closely related to changes in trade figures because Singapore is an open economy. Hence, with the decrease in trade, Singapore real GDP declines. Labour productivity in the economy has also been declining due to recession. Cyclical unemployment rate increases due to recession as workers are unable to secure similar paying jobs. Companies are encouraged to make cut wages instead of retrenchment. Consumption will decrease as people have less income due to pay cut or retrenchment. The industries that were adversely affected by job losses are manufacturing, transport, tourism and wholesale trade since these sectors are most exposed to the external economic environment. The manufacturing industry, which accounts for a quarter of the economy, contracted 11.5 percent in 2009 last quarter, compared with a revised 4.9 percent drop in the previous three months, mainly due to the persistent weakness in global demand for electronics, chemicals and biomedical products. Due to this financial crisis, Monetary Authority of Singapore (MAS) eases its monetary policy to combat slowing growth. In order to boost export, MAS shifted Singapore dollar to a neutral stance, making it cheaper in relatio n to other major currencies and making domestic exports competitive. The Singapore currency has declined 8.1 percent against the U.S. dollar in that period. However, this also implies that import of necessities will be more expensive which will affect the purchasing power of people, i.e. people will spend less. There will be lesser business for companies and they will be struggling to stay afloat. Inflation in 2008 was 6.5%, higher than expected owing to rising oil and commodity prices. Hence, we can see supermarkets like NTUC selling many household brands to help the poor/middle aged families to survive this financial crisis. Due to expectations that inflation will get worse, consumers will curb their spending and consumption decrease as a result. The exposure of Singapores banks to sub-prime mortgage is limited. Economic conditions in Singapore have been affected by the massive loss in wealth from the collapse of the stock market. This in turn reduces consumption and investm ent in assets. Businesses might not have the operating capital and some businesses cannot meet their operating expenses. The government plays an important role to combat recession. They tapped its reserves to tackle this crisis and implemented ways to boost infrastructure spending and public aid in its Budget. 2) The Singapore governments year-long scheme to help companies avoid retrenchments and keep unemployment numbers down has been extended for another six months till June 2010. (a) Explain the likely causes of unemployment in Singapore. The causes of unemployment in Singapore can be described under 3 categories namely, frictional unemployment, structural unemployment and cyclical unemployment. Frictional unemployment is short term unemployment associated with the process of matching workers with jobs. This is commonly seen in Singapore as people will always spend time to look for better jobs e.g. higher pay, higher satisfaction based on their competency. One example will be university graduates who may need more time to search for jobs at an acceptable salary. Structural unemployment is long term and chronic unemployment which happens due to regular and predictable changes in labour demand.Due to the revolving world, everything is changing which might lead to a decrease in demand for certain goods/services. Hence, structural unemployment may arise due to rapid changes in technology. Besides that, it could also be due to lack of relevant skills which are in demand by the employers, language barriers, discrimi nation on the basis of age, ethnicity and race and long-term mismatch as employees need time to learn new skills. Major shifts of consumption taste and a variety of other factors can reduce the demand for certain skills and increase that of others, thus making structural unemployment occur. Structural unemployment also exists where there is a mismatch between the skills of the workforce and the requirements of job opportunities or the workers live too far from the demanding area. For example, many unemployed workers from manufacturing industry found it difficult to find new jobs without re-training. Cyclical unemployment depends on the business cycle. It will arise when there is a recession (lowest peak of the business cycle) as the business cycle is low and many firms will reduce the demand for inputs, including labor in recessional periods when production declines. On the other hand, cyclical unemployment will decrease when there is economic growth (highest peak of the busin ess cycle) because total economic output is being maximized. b) Describe the various policies implemented by the Singapore government to solve the problem of increasing unemployment. PM New Year message 2010 mentioned that the government will continue to focus on preserving jobs, and helping workers who are unemployed to find new jobs. In December 2008, the tripartite partners launched the Skills Programme for Upgrading and Resilience (SPUR). SPUR was included in the Resilience Package in an early Budget 2009. SPUR offers training programmes to help workers upgrade their skills or acquire new skills for seeking re-employment. Through SPUR, workers have an opportunity to gain a competitive edge in the job market while employers are able to manage manpower, save manpower costs and retain workers by involving them in skills upgrading and development. This allows workers to stay employed, save jobs and strengthen their individual abilities during the recent economic downturn. Furthermore, the government also introduces a Jobs Credit scheme to help employers to retain their workers. This enables businesses to save jobs as much as possible, without the need to retrench workers. The Jobs Credit provides every employer with a cash grant to reduce their costs of employing Singaporean workers during the crisis. Hence, more Singaporeans will be employed. Workers have to make necessary changes in this economic downturn such as getting lower wages etc to remain competitive and save jobs. Businesses also have to find ways to cut unnecessary costs in their operations to save jobs. Furthermore, there is also a skill development fund (SDF) to subsidise training fees and its main objective is to give financial assistance to employers in order to encourage them to train/upgrade the skills of their workers. Continuing Education and Training (CET) Masterplan is another plan to prepare Singaporean workers for the future and develop a source of competitive advantage for Singapore. Workers can get help and advices on jobs and training that are suitable for them. Government is investing in this plan so that about 60% of residents can have a diploma qualification by 2010 and this helps to equip Singaporeans with the necessary skills when they are preparing to switch careers. It also forms a lifelong learning system to help workers find their potentials and seize new opportunities. Moreover, the government increased the mandatory retirement age to 62 to help workers stay employed longer. c) Evaluate the effectiveness of the Jobs Credit Scheme in reducing unemployment. Jobs Credit Scheme is implemented to encourage businesses to sustain jobs for Singaporeans in the economic downturn. This will provide every employer with a 12% cash grant (on the first $2,500 of monthly wages of each local employee on their CPF payroll) to reduce their costs of employing Singaporean workers during the crisis. Hence, it is encouraged that employers would hire Singaporean labour instead of hiring foreign labor (as they are cheaper) so as to enhance the competitiveness of Singaporean labour in the job market. This can help to reduce the unemployment rate for Singaporeans. However, a drawback of this scheme is that unprofitable companies would rather retrench workers than receive cash grant from the government. Hence, companies which will benefit from this scheme are usually big and stable companies which are able to survive through the recession. This is compared to smaller companies because they have to resort to measures such as retrenchments or cutting down cos ts in order to stay afloat. As such, higher unemployment and more job losses will still be inevitable. This scheme will also imply that companies would be more willing to hire local graduates. In contrast, foreigners need not contribute to CPF, unless they become Permanent Residents (PR) or Citizens. Without employees contribution, there would be no employers contribution and thus, hiring a foreigner is cheaper and many companies will still hire foreigners despite the benefits of the Job Credit Scheme. This scheme may also stop and employer would no longer receive cash grants for his contribution to the local graduates CPF account. As a result, employers would prefer to hire foreign graduates than local graduates due to the fact that it would be cheaper in the long run. Hence, the main issue is how long this job credit will run. It is impractical that it lasts for only a short term within this economic crisis because employability should be considered on a long-term scale. 3. Explain and evaluate the effectiveness of the other various fiscal policies which the government implemented in 2009 to deal with the economic crisis. (20 marks) The government has implemented the Resilience Package of $20.5 billion, to cope with an economic downturn. It includes measures to prevent loss of jobs, enhance business cash flow and provide support for Singaporeans as well as investments in infrastructure for the long term. The Resilience Package consists of five components: (i) Jobs for Singaporeans. $5.1 billion would be spent to help preserve jobs through Job Credits Scheme and related programmes like SPUR. This allows businesses to cope with cash flow. The Government will give low-income workers a temporary workfare income supplement (WIS) Special Payment to supplement their pay and encourage them to stay employed. The government will also create more jobs. (ii) Stimulating bank lending. The Government will launch the Special Risk-Sharing Initiative (SRI) to enable companies to have access to credit to continue their operations and preserve jobs. The Government will also enhance existing loan schemes e.g. local enterprise finance scheme and they have dipped into reserves to fund both SRI and Jobs Credits. (iii) Enhancing business cash-flow and competitiveness. Various tax measures and grants costing $2.6 billion would be implemented to help businesses with cash-flow and enhance competitiveness. Taxes work as an automatic stabiliser and this is evident in years of low GDP growth where, taxes would be reduced to encourage investments. (iv) Supporting families. $2.6 billion would be used to support Singaporean households especially lower-income households. The government will provide assistance to households i.e. increasing goods and services tax (GST) credits and senior citizens bonus, focus more on the most vulnerable groups by providing financial assistance schemes for education and provide support for charitable organisations and the community i.e. increasing citizens consultative committees (CCCs) ComCare fund and self-help groups (SHGs). (v) Building a home for the future. The Government will commit $4.4 billion to infrastructure development as it is an important feature of Singapores fiscal strategy. Hence, the government will bring forward infrastructure projects and spend on accelerating public sector infrastructure, developing our neighbourhoods and spending more on education and health infrastructure (due to aging population). I will say that the Resilience Package is effective because it has helped to reduce the unemployment rate in Singapore during an economic crisis. One example is NTUC which had work closely with employers to save jobs, instead of retrenchment to save costs. They have also sent workers for SPUR training and skills upgrading. Furthermore, this is evident that the Resilience Package helped Singaporeans from the economic crisis. Despite sharp declines in our GDP, foreign worker numbers fell 21,000, but local employment actually went up by 7,000 in the first half of 2009 which shows that Jobs Credit Scheme is effective. However, the Resilience Package is ineffective as it contains temporary measures such as the Jobs Credit for all businesses and Special Risk-Sharing Initiative which not be built into ongoing government programmes. Our government uses the discretionary fiscal policy (running a larger deficit in a year of low growth) which provides tax rebates to reduce tax collections, and spend more on goods and services, grants or tax credits to increase incomes. The effectiveness of discretionary fiscal policy is enhanced by the short implementation lags in Singapore due to our efficient tax and CPF systems that enable the Government to distribute transfers quickly. Fiscal policy in Singapore is financed from accumulated budget surpluses i.e. past reserves rather than from borrowing. This enhances the impact of temporary measures. However, discretionary fiscal policy has its limitations. Singapore is an open country. Hence, using it as a tool for macroeconomic stabilisation is more limi ted due to leakages of imports. Fiscal transfers on aggregate demand would not be effective because a portion of injections into households/businesses are kept as savings. On fiscal policy, reserves built up during the past years of strong economic growth reduce government charges and boost spending. Multiplier of discretionary fiscal measures is insignificant. Targeted transfers at the lower income such as GST Credits tend to have a higher multiplier. However, taxes and investments tend to have a lower multiplier which provide a longer term period to economic growth. It is clear that the Singapore economy cannot be left to recover on its own unless changes in policy are made. The government has already taken some measures to reduce costs and taxes over the last few months. These were steps in the right direction, but they were not the complete solutions to the problem. These changes should be implemented with the longer term developmental needs of the economy. 4. Some economists have warned about the possibility of a double-dip recession, with economic contraction following the current recovery. In your opinion, what is the likelihood of this happening? Give your reasons. (10 marks) I feel that Singapore is unlikely to sink back into recession as our financial sector is recovering, with assets of the 20 largest fund managers in Singapore growing 23 per cent in the first half of 2009. A reason why Singapore is unlikely to sink back into recession is because of the global competiveness. The world is cooperating on several projects which include Asia-Pacific Economic Cooperation (APEC) and G20. APEC is a forum which facilitates economic growth, cooperation, trade and investment in the Asia-Pacific region. APEC creates efficient domestic economies and increasing exports. Free and open trade and investment enables economies to grow, creates jobs and provides new opportunities for international trade and investment. Singapore will work with like-minded economies and international financial institutions like the IMF, World Bank and Asian Development Bank to advance free trade. G20 is an UN climate change conference where countries will come together to solve th e problem of climate change and work towards an ambitious outcome in Copenhagen. From here, we can see that protectionism, which could affect global trade and growth, has been closely monitored. Singapore is working towards closer regional economic integration and pursuing different free-trade initiatives to expand our economic network. We are restructuring our economy so that it remains nimble and competitive. The government has taken a few measures to revive demand in the system through stimulus package. They guarantee that businesses will have sufficient funds for their daily operations. Given our strong economic fundamentals, the government is able to take rational measures. Furthermore, the savings we have put away (by building reserves) during good times, Singaporeans tackling challenges together and social cohesion will bring us through this economic downturn. 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