Global Financial Crisis (GFC) took place in the year 2008 and is acknowledged as one of the outrageous debt crises occurred in the history of capitalist development since the financial crisis of 1929 (Ciro 2016). It will not only be discussed in its scope and depth, in addition to this deep-seeded monetary and fiscal policy taken to reduce the repercussion effect is the other major reasons. Considering the New Keynesian view regarding the great depression various economists like Krugman, Friedman, Stiglitz has argued that the present global crisis has been germinated through the insufficient demand in the market (Cohn 2017). Financialization, on the other hand, states that there has been distorted financial agreement between the various parties that have created artificial financial wealth disconnected from the production of goods and services and real wealth (Bresser-Pereira 2017). Capitalism model in the present scenario is unstable in its nature and the financialization policy is highly open to provide mutual development scope to the trade participating nations. Under this situation, this report is aimed to provide a comparison and contrast to the causes and consequences of the 2007 – 2008 crises, coined as the Global Financial Crisis from the New Keynesian and financialization perspective. In addition to this, the essay is aimed to critically explain which of this theoretical model explains the GFC properly through comparative analysis of the both. To conclude the essay will provide a summarized overview of its finding and portray how over the time various theories have explained the GFC efficiently.
During the year 1935 J M Keynes came with this Theory of Employment, Interest, and Money that not only changed the economic perspective regarding the macroeconomic variables, in addition to this it has altered the mindset of the policymakers (Keynes 2016). Keynes redefined the economic perspective regarding the financial crisis of 1929 and made it clear that orthodox price-based economic framework is no more applicable during the age of rapid industrialization (Davidson 2017). Rather it is necessary for the government to keep some amount of deficit in the market for in order to attain full employment. So, how does the Keynesian model fits in the recent Global Financial Crisis situation of 2008? Various researchers have been performed researches to trace why GFC like situation has arrived and how New Keynesian theory has aided the policymakers to gauge the situation, makes it a well-documented research work.
According to the Brunnermeier (2009), it has been argued that many economies around the world have considered the insufficient aggregate demand as the key instrument for the world economic crisis like GFC that took place in the year during 2008. Keynesian theory argues in favor of the insufficient demand approach that leads to global productivity unbalance and imbalance in the income distribution leading to a large amount of capital accumulation only by a sector of world population (Peet and Hartwick 2015). This polarized the distribution of the income allowing the capitalist to look into new channels for investment in order to generate profit that leads to the vast amount of international hot money resulting into a financial bubble. Historically it has been observed that this hot money leads to series of recession in the interconnected economies and the repercussion effect is long lasting in absence of the proper governmental approach (Bortz 2016). Previously it was assumed that any crisis can be overcome with the demand and price adjustment; however, Keynes shows that it is not applicable today where the recession in the economy is coming over the period in a cyclical manner. As it can be seen in the GFC situation, there was huge money inflow into US banks during 2000 to 2006 in the form of hot money that created the subprime mortgage bubble. Empirically it has been observed that during 1998 there were 0.63 billion future contracts in the US and the figure soar up to 3.2 billion during 2007 that allowed a vast amount of hedge fund in the US economy (Tori and Onaran 2015). Contrary to this, according to the International Monetary Fund data of 2007, national income of the rich countries was 445 times higher than the poor countries (Chen et al. 2016). 90% of the world population possesses the 50.4% of total wealth and the remaining 49.6 of wealth is possessed by the richest 10% population of the world (Atkinson and Bourguignon 2014).
Figure 1: Standard deviation of income as % of GDP in US
Source: (Koo, 2018)
From the figure 1, it can be seen that there was high inequality in the income distribution in the US over the time. According to Koo (2018), from 1980, there was a high disparity in income in the US and over the time yet increased gradually. According to the same source during 2006, income disparity increased to the highest level leading to the supply-demand gap. This highlights the level of disparity in the world economy. If the country wise condition can be considered, then it can be seen that rich country has 45% of its total wealth possessed by the 5% population and in the case of poor countries rich population absorbs the 77% of nation’s total wealth (Tori and Onaran 2015). This has caused inevitable outcome in the case of demand fall. Economic Scenario of the world during 2008 GFC was so tensed that even real demand of the market was not enough to satisfy the capital over expansion and fall in effective demand. New Keynesian approach from the analysis of the GFC has found that insufficient demand presence in the market has been transpired through the improper macroeconomic management and restrictive monetary policy by the respective governments. Additionally, one of the main reasons that quantify the demand crunch is the insufficient spending and asymmetric information that allowed the economies to perform moral hazard to the population. Falling Marginal Efficiency of Capital (MEC) is another reason highlighted by the Keynes that lead to fall in the investment leading to recession in the economy (Bortz 2017). According to the same source, it can be seen that during 2008, overall total investment in the world has subsequently fallen that allowed to a higher amount of labor unemployment around the world and caused fall in the Marginal Efficiency of Capital loss.
Figure 3: Liquidity injection failure
Source: (Koo, 2018)
Over the time due to financialization, there has been fall in demand of the domestic as well as foreign investment that leads to the deflation in the economy. From figure 2, it can be seen that reducing demand and supply, the economy was falling apart from the expected growth path. The above figure also highlights that bank lending as well the monetary base of the country has lowered over the time during 2006 to 2011. Lack of the investment propensity by the domestic and the private sector lead to business cycle lead recession and the debt minimization. Borrowing of the country hasn’t changed during the same period that reduced the economic growth and leads the economy to face one of the largest recessions in the history. However, like Taylor and Rogoff argued that recent global crisis has been originated from the aggregate over absorption (Lo and Rogoff 2015). They argue that financial crisis took place in the US due to the excessive hedge money inflow from the foreign nation in spite of lack of aggregate demand leading to subprime mortgage bubble soar. This germinated the theory of underemployment, which aided the self-adjusting nature of the economy under the crisis situation. thus according to the Keynesian view of the GFC, it has been germinated through the lack of ability of the capitalist economy to clear the labor market and next to this demand management policy of the government were not what that it should be according to the Keynes (Means 2017). Keeping the unemployment level to the natural level and shifting to inflation target achieving method is another turning point that brought in the recession in the world during 2008.
Financialization is another view that aids to trace the causes and consequences of the GFC that took place in the year 2008. According to the financialization, the aforesaid financial crisis is the direct outcome of the hegemony of intransigent ideology such as neoliberalism (Petras et al. 2016). In the case of the 2008 GFC, Financialization can be considered as the distorted financial agreement between the parties that created artificial financial wealth disconnected from the production of services and goods and from the real wealth. It is based on the perceived value of the good and services that really do not present in the market, which subsequently failed the financial innovations. Financialization came into existence during 1980 when two poorly performing nation namely US and UK came under the agreement and shifted the economy from orthodox capitalist model to financialization model with the coalition of top business executives in the respective countries (Pump 2016). Financialization was expected to bring in more capital inflow to these participating nations that would help to restore the depleting financial stock and help the country to have better growth prospect mitigating the issues of recession. Now considering the financialization GFC can be explained and its consequences can be assessed easily. From 1980 to 2007, it can be seen that the US had the highest growth in its financial assets (Karwowski and Stockhammer 2017). Over this period compared to the real wealth financial assets of the country rose by more than four times of its GDP growth. Hence, it reflected the blurred reality to the investors regarding the strength, weakness and the present condition of the US economy. It allowed the investors to invest more amount of fund in the US market that allowed the subprime mortgage rate to rise. with rising investment, the interest rate was about to fall; however, US insurance firms didn’t allow the Fed to reduce the interest rate to fall and year by year there has been a cyclical rise in the investment in US market that has been forcing the mortgage crisis into a worse condition.
Figure 2: Debt in financial sectors of US
Source: (Stockhammer, 2018)
As it can be seen from the figure 2, due to raising in the financialization, debt in the US financial sectors has been enhanced over the time. It has caused a rise in the financial debt at an alarming rate every rate. During the end of the 2006 financial debt was as high as the 1% of the GDP compared to the previous year that portrays the poor condition of the market (Stockhammer, 2018). Financialization allowed the firm to invest in the short term assets in the US market rather than investing into irreversible long-term fixed assets that pinned the last kneel in the subprime mortgage crisis. For instance, US stock market capitalization enhanced by whopping 383% during 2008 compared to the 1988 situation (Stockhammer, 2018). According to the same source, it is acknowledged as one of the reasons for rise in subprime mortgage crisis. The same source mentioned that on the other hand debt in financial sector increased from 16% during 2000 to 111% during 2009 that lead to fall in the trust in over the mortgage market. Once misbelieve among the investors started to grow the subprime mortgage burst out. With the financial crisis, worsening day by day investors rushed to cash their mortgages, but the insurer does not have any fund to return to the investors. It was inevitable because financialization is a socio-economic process that promotes itself as the retarder of the financial expansion of the economic system. Thus, from the financialization perspective, the rapid growth of the economy in absence of any linkage between the real wealth and the perceived wealth the economy has faced crisis and the interlinkage between the crisis allowed it to spread around the various economic like fire. According to (Brunnermeier 2009), financialization is one of the key instrument that allowed subprime mortgage fall due to the rise in the financial expansion and it spread rapidly around the world due to the interconnection between the various financial institution around the world achieved through the technological stockpiling (Lothian 2017).
Both the Keynesian and Financialization view of the recent Global Financial Crisis took place in the year 2008 has been portrayed. From the comparative analysis, it can be stated that these two ideologies differ from each other to large extent. New Keynesian economists argue that there has been a substantial amount of demand crunch the market due to the polarization of the national wealth. This has caused a wide gap in the economy leading to falling in the aggregate demand and leading to falling in the MEC (World Economic Forum 2018). In spite of that US, investors sold the mortgages in chunks without even any backing from the government. Contrary to this it has been argued by the financialization theorists that substantial amount of expansion of the US economy with the various treaties and deals allowed the economy to face the crisis. Difference between the real market scenario and the perceived wealth condition of the US financial assets allowed the investors to invest in higher amount (Kidwell et al. 2016). However, they were provided scope to invest only in the retractable short-term plans that can be withdrawn from the market fluctuation. Capitalism model, on the other hand in the present scenario, is unstable in its nature and the financialization policy is highly open to provide mutual development scope to the trade participating nations (Streeck 2014).
This essay has been framed utilizing the two models for describing the Global Financial Crisis that took place in 2008. From the comparative analysis, it has been found that both the model has some common features and loopholes. Considering the Keynesian model, it can be stated that the model was focused mainly on the demand crunch of the economy and it failed to assess the other effect of socio-economic transformation (Castells 2017). Contrary to this, financialization is another model that considers the socio-economic framework, however, fails to consider the wide range of other factors that may have contributed in the Global Financial Crisis (Fernandez and Albers 2016). In addition to this, it fails to consider the cyclical effect of the recession that occurs in every economy after a certain interval of time. Rather its focus mainly on the interlinkage between the various economies. In addition to this, it can also be stated that the financialization is one of the best theory that describes how subprime mortgage crisis in the US economy has transformed itself into a global epidemic, and on the other hand New Keynesian model to some extent explain the GFC in a more appropriate way that argues in favor of strong governmental intervention in case of any future crisis like GFC.
Conclusion:
The essay was aimed to discuss the various perspective of the Global Financial Crisis that took place during 2008. The easy was performed by analyzing the previous researches and tracing how Keynesian model can fit into the present situation that has been germinated during 1929. In addition to this, the report has also utilized the financialization view that came into existence during 1980. Through the analysis, it has been found that the aforementioned two theories have a different perspective regarding the Global Financial Crisis. New Keynesian model argues in favor of the demand crunch that leads to the GFC and on the other hand it has been argued by the financialization that interlinkage between the nation and the financial expansion has to lead the world economy face a recent global crisis. However, through comparative analysis, it has been found that the Keynesian view is the ideal between the two selected views to describe the GFC. Financialization is one of the best theory that describes how subprime mortgage crisis in the US economy has transformed itself into a global epidemic and Keynesian economy suggests how demand crunch caused the epidemic with doses to deal with the future situation like this.
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