Intrinsic and Rational Speculative Bubbles †MyAssignmenthelp.com

Question: Discuss about the Intrinsic and Rational Speculative Bubbles. Answer: Introduction: The given statement is false. If government want to increase demand by $5 billion then it has to carry out government spending greater than $5 billion. The effect on aggregate demand because of fiscal policy expansion depends on the multiplier effect derived from the IS curve (Palley, 2015). For a closed economy the effect of change in government expenditure on aggregate demand depends on the multiplier given as The expansionary fiscal policy leads to an increase in interest rate, which affect investment and dampen the expansionary effect. This is called crowding out effect. In the open economy the additional leakage exits induced by imports. The open economy with a fixed exchange rate regime has a smaller crowding out effect than the closed economy. Once the economy move from fixed to flexible exchange rate regime the situation is reversed. With flexible exchange rate, the interest rate alters the net export and creates crowding out both in domestic and international market. In a restrictive monetary policy, the monetary authority reduces money supply in the economy. The reduced money supply increases the interest rate in the credit market. The economy contracts and so is the consumption and investment. With a higher interest rate, the cost of borrowing fund increases and people borrow less fund to invest in housing market (Calza, Monacelli Stracca, 2013). The reduced demand for housing property reduces housing price. Any exogenous factor that influences housing demand can counter the situation. The fiscal stimulus in form of concession of taxes because of investing in credit market can make housing investment more lucrative and boost prices. Another condition that can prevent housing price from falling a low level is the immigration in the nation. Growing demand for immigrant accommodation maintain a balanced in demand and price. In United State, housing bubble burst because of sudden fall in interest rate and leads to financial crisis. Australia is another example of nation facing crisis in the property market because of monetary policy and other external factors. In order to achieve targeted inflation rate and economic growth Bank of Canada reduces the overnight interest rate. The policy include prime lending rate and mortgage rate as well. The lower interest rate make ownership of home more affordable and benefits the homeowners by raising demand for properties and properties. The decreases in the mortgage rate affect homeownership to a broader population segment. It helps the homeowners to fulfill the ambition of home owning and buy expensive houses. The homeowners enjoy a wealth affect because of raising property price without taking any action (Allen et al., 2016). In Canada, tax concessions are provided to purchase new house or even to renovate the existing houses. Other programs in Canada provide benefit to homeowners. One example of the beneficiary program is Home Buyers Plan. It allows withdraw of fun amount up to $25,000 from the retirement saving plan to finance purchasing of new home or construction. Home accessibility tax credit is another tax policy that allows a claimed tax concession up to $10,000. The economic policy framework of the governing authorities of a country has immense implications on the overall economic welfare of the residents living in the country as well as the economic health of the country itself. Economic policies are mainly classified into two types, the fiscal policies, which collectively deal with taxing and government expenditure and productivity aspects and the monetary policies, which are primarily concerned with the regulation of the money supply and the interest rates prevailing in the country (Sterner, 2012). Therefore, a lot of the economic welfare of the country as well as its residents depend on how efficient the policy framework is and any faulty and inefficient policy, fiscal as well as monetary, can have immense negative implications on the country in an overall framework. The essay, tries to capture this aspect of a faulty policy framework on the overall economy, taking reference of the Global Economic Crisis of 2008, which started in the USA and percolated to almost all the other parts of the world with time (Rios, McConnell Brue, 2013). One of the most notable economic phenomena, in the global scenario, which had immense and long term implications (mostly negative) on almost all the major economies of the of the world, was the Global Financial Crisis, which occurred in 2008, which had its initiation in the United States of America. The primary reason behind the occurrence of the Global Financial Crisis, as asserted by many eminent economists, all over the world, was the bursting of the investment bubble in the housing sector of the country. This was fallout of shortsighted economic policy structure of the country and the wrong speculations of the investment side players involved (McDonald Stokes, 2013). Housing Bubble: Creation and Burst Before the period of occurrence of the Financial Crisis, the housing sector of the country was experiencing a boom in the real estate sector, especially the housing sector of the economy. The housing prices were steadily and impressively increasing in the country, in the decade preceding the crisis, which can be seen from the following figure: One of the primary contributing factors in this hike in the housing prices in the country was the speculation of the investors (which also included the households) in this sector, who took the residential properties as a type of asset. Thus, started investing more and more in this sector with the speculation the prices of these assets would never fall. The households also showed the similar investment pattern and were backed by the monetary policies of the then government, which in order to facilitate more investment in this sector, designed the loan and mortgage policies in the real sector accordingly. The interest rates prevailing in the country, in this aspect, were exceptionally low to encourage investment in the residential sector, by proving easy borrowing and financing facilities to the investors. The housing tax policies of the country were also designed in such a way which increased the risk taking behavior of both the investors as well as the banks and the financial institutions, the providers of the loans, extensively (Berkmen et al., 2012). This created a huge immense bubble in this sector with time and when the interest rates started rising in the succeeding periods, the housing bubble burst in the economy, which led to immense negative repercussions including one of the biggest bankruptcies in the world, of that of the Lehman Brothers, with which the Global Financial Crisis started. Conclusion From the above discussion of one of the biggest real case economic phenomena in the world, it is evident that much of the economic welfare of a country as well as its residents, both short term as well as long term, depend on the economic policy frameworks of the country as well as of the global economic scenario. Any dynamics in the same is expected to have significant implications on the economy itself. References Allen, J., Grieder, T., Peterson, B. M., Roberts, T. (2016). The impact of macroprudential housing finance tools in Canada: 2005-10. Berkmen, S. P., Gelos, G., Rennhack, R., Walsh, J. P. (2012). The global financial crisis: Explaining cross-country differences in the output impact.Journal of International Money and Finance,31(1), 42-59. Calza, A., Monacelli, T., Stracca, L. (2013). Housing finance and monetary policy.Journal of the European Economic Association,11(suppl_1), 101-122. McDonald, J. F., Stokes, H. H. (2013). Monetary policy and the housing bubble.The Journal of Real Estate Finance and Economics,46(3), 437-451. Nneji, O., Brooks, C., Ward, C. (2013). Intrinsic and rational speculative bubbles in the US housing market: 1960-2011.Journal of Real Estate Research,35(2), 121-151. Palley, T. I. (2015). Money, fiscal policy, and interest rates: A critique of Modern Monetary Theory.Review of Political Economy,27(1), 1-23. Rios, M. C., McConnell, C. R., Brue, S. L. (2013).Economics: Principles, problems, and policies. McGraw-Hill. Sterner, T. (Ed.). (2012).Economic policies for sustainable development(Vol. 7). Springer Science Business Media.