The Global Financial Crisis of 1997-1998, Research Paper Example

Abstract

For the past 10 years, the global financial crisis of 1997-1998 has affected New Zealand’s economy. This paper will discuss how the global financial crisis has influenced the economy in New Zealand. Also, which policies were more effective in addressing its economic issues. Likewise, IS-LM, a macroeconomic theory, has been used to explain economic conditions in New Zealand. This paper will focus more on how IS-LM has been used by government to bring economic prosperity back to New Zealand.

Introduction

New Zealand has been greatly affected by a Global financial Crisis (GFC) in the last 10 years. The purpose of this research is to evaluate the polices used by New Zealand’s government in the midst of a financial crisis during 2007-2008.(Johnson & Blanchard, 2013) First, the paper will analyze how New Zealand’s economy functioned amidst a global crisis and which strategy was more effective. Secondly, what influenced the use of the policy have on other facing the crisis. The conclusion will summarize the findings and make recommendations for how the information may be used.

The Global Financial Crisis of 2007-2008 has been considered the worse financial crisis to hit New Zealand since 1930. Global financial Crisis (GFC) in 2007-2008 was the worst financial crisis since 1930. Housing prices had doubled in the United States in 2007, which was doubled since the housing decline in 2000. The decline in housing purchases led to unpaid loans. In addition to this, home owner lost money value of their homes because of the decline market. Those who sold homes often still loss money they had put into them. So, bankers and citizens were affected by the financial crisis in New Zealand. For example, the renowned Lehman Brothers of the United States filed for bankruptcy on September 15, 2008. They noted that they had acquired too many mortgages that were now accessed at lower value. Eventually, the U.S. economy bottom-upped as well. This created a domino effect because the Lehman Brothers were affiliated with other bankers around the world. As a result, other banks went bankrupt or were on the brink of bankrupt due to various macroeconomic factors. Banks in America, New Zealand, and Australia were affected. (Johnson & Blanchard, 2013)

A review of theoretical literature

One important theory in macroeconomics is IS-LM. It analyzes how policies and other elements affect a global crisis situation. It then conveys what strategies were more effective in rebounding the country’s economy. As a result, the IS-LM model is the most widely used instrument by economist today. The IS-LM model is an extremely important theory in macroeconomic. The IS-LM model will be discussed in details along with its functions. . (Johnson & Blanchard, 2013)

Foremost, the IS relation of a condition(Y) has to be equal to the demand for the product. (Z), in other words, there must be a balance between demand and goods to balance the market. Likewise, the demand for products (Z) is based upon the demand of products(C), investment (I) and government spending (G). Therefore, a good market formula becomes Y = C(Y-T) + I(Y, i) + G.(Johnson & Blanchard, 2013) The market is affected by all these factors. It is because each is affected by the other. Demand is calculated by gross income. However, the investment depends on two different factors-sales(i) and interest rates. Sales and investment have a positive effect on each other. One cannot increase without the other. For example, a factory producing cars must increase their production due to demand of the product. This shows the positive relationship between investment and sales.  It shows the positive relationship between investment and the level of sale. Nevertheless, once interests rates increase, a drop in investments is often seen. When interest rates are high, a car producer will lower its production. So, there is a negative relationship between interest rate and investments. (Johnson & Blanchard, 2013)

Next, the IS curve is a downward slope on a graph. When the interest rates grow, it reduces the output of the economy. As a result, interest rates increasing and decreasing will cause the curve to move up and down. In a visual representation, and IS curve sloping downward represents the interest rate is growing. Interest rates can be influenced by taxes and government spending. Essentially, output depends upon consumer spending. When taxes increase, consumer spending drops. This drop in spending causes a shift in the IS curve. Nevertheless, when there is an IS shift to the right, it represents a decrease in taxes and governmental spending. (Johnson & Blanchard, 2013)

Yet, the LM curve is representation of the financial market that focuses primarily on supply and demand. The equation for this scenario is, M=$Y L(i), M is representation of nominal stock, which is usually controlled by a central bank. Countries that not use this method are in fear of collapse.  Nevertheless, the GDP is an important factor in the equation. Its equation is M/P =$Y L (i) . The relationship between money, nominal income, and the interest rate is the equilibrium of the conditions

The LM curve reflects the relationship between income and interest rate. LM curve is depicted by an upward slope that increases as the income increases.Likewise, the demand for money rises, however the supply of money has to equal the demand for money.When consumers reserve money in banks the supply of money and demand coincide. So, the LM curve is representation of increase and decrease of money. The curve of the LM is shifted downward when money increases. It shifts upward when interest rates rise. (Johnson & Blanchard, 2013)

Consequently, the IS-LM model is a depiction of both the IS curve and the LM curve. The IS curve is representative of the product market when supplies are equal to demand. A scenario of this nature can only be affected by taxes. The LM is representative of the financial market and its influence by money stock. This occurs when the supply of money is equal to the demand for money.  The combination of both curves is representative when both conditions are satisfied. (Johnson & Blanchard, 2013)

In today’s society, governmental banks and policy adjust the interest level according to the country’s economy level. This changes from one extreme to the next depending upon the country’s economic situation. When the country is facing a economic situation, the government will announce a strategy to increase tax revenues. When there is a shortage in revenue, the government began strategies to increase on-hand revenue. So, those who are aware of varying strategies to increase tax, can predict economic disaster by observing governmental strategies. So, IS-LM is direct reflection of an economy’s condition and conveys the results of those strategies. (Johnson & Blanchard, 2013)

Analysis and Evaluation of Policy

The Official Cash Rate (OCR) is set by the Reserve Bank and helps to prevent sudden issues that can negatively or positively affect the economy. This interest rate is targeted by the Policy Targets  Agreement, which steadies the consumer Price Index(CPI) between 1 and 3 percent on average. This agreement was signed in September 2012. The purpose of this rate is to determine and control the price of borrowing money in New Zealand. It also allows the Reserve Bank to dominate the economy level and inflation activity. (Reserve Bank of New Zealand, 2014)

The Reserve Bank is a central bank in most countries. All registered banks must have agreements with the Reserve Bank. The reserve banks interact significantly with each other daily. Some of their interactions may be a simple as paying interest rates on accounts. The OCG is in charge of interest rates, which allows it to control the money stock within the country. As a result, the borrowing rate is dependent upon the OCR rate. Therefore, banks must remain within a certain rate in order to be able to pay their interest to the Reserve Bank(Reserve Bank of New Zealand, 2014)

On the other side of the issue, the global crisis of 2008, affected New Zealand’s economy more than any other country. The high cost of fuel and food prices alone made life nearly impossible for some consumers. Consequently, the purchasing of dairy products was drastically low during the first few months of 2008. In addition, fewer investors were willing to chance their money. This also led to a drop in inventory and imports from overseas companies. Likewise, less revenue was raised from tourism. (The Treasury, 2010)

Because of the risk global financial problems, the government and the Reserve Bank in New Zealand finally implemented strategies to remedy the situation. The first strategy was for the OCR to dropits rates from 8.25% in July 2008 to 2.5% at the end of April 2009. The next strategy was for the Reserve Bank to ensure that other banks had sufficient liquidity. Finally, the personal income tax was reduced by the government on 1 October 2008. (The Treasury, 2010)

Goods and Financial markets crashed due to CFC. In order to shed light on the crisis, the IS-Lm theory was used. The government and the Reserve Bank used a mixture of the theories mentioned before. The reduction the OCR rate led the LM curve shift down. The Reserve Bank  hoped this strategy would increase the output in New Zealand by improving its money supply. When the government decreased the taxes the IS curve shifted to the right , but the output increased and the interest rate stayed at the same. The goal of  New Zealand’s government and the Reserve Bank was to raise the level of output to its normal level of function. This goal was significant  because an increase in  amount of output can lead to an income increase for residents in New Zealand . With increased income, the residents would buy more products. This would increase the money stock in New Zealand.(Johnson & Blanchard, 2013) (Reserve Bank of New Zealand, 2014) (The Treasury, 2010)

Conclusion

This report analyzed the macroeconomics model- IS-LM. It examined how various elements effect global financial issues in New Zealand. The various strategies and theories show a direct correlation between consumers and the economy. Nevertheless, the paper sought to show that financial crisis in New Zealand can affect various other countries. Finally, the paper conveyed the role of the Reserve Bank and policies to balance out economic output and input.

Bibliography

Johnson, & Blanchard. (2013). Macroeconomics Updated, Internation Edition (6th ed). Boston.

Reserve Bank of New Zealand. (2014). Reserve Bank of New Zealand. Retrieved from Reserve Bank of New Zealand: http://www.rbnz.govt.nz/monetary_policy/about_monetary_policy/0072140.html

The Treasury. (2010). The Economy of New Zealand: Overview. Retrieved from http://www.treasury.govt.nz/economy/overview/2010/04.htm