ECON 330 Study Guide - Midterm Guide: Cash Flow, Currency Crisis, Adverse Selection
Document Summary
6 categories of factors for financial crisis: asset mkt effects on balance sheets. * raises the value of borrowing firms liabilities w/o raising their assets. Their net worth (in real terms) decreases. Unanticipated decline in the value of the domestic currency. * deterioration in firm"s balance sheets --- decline in net worth. * leads to contraction of lending: deterioration in financial institutions" balance sheets. * fewer resources to lend thus lending will decline. Less capital leads to a decline in investment spending --- slows economic activity: banking crisis. Fear can causes healthy banks to close. * multiple banks fail simultaneously --- source = asymmetric information. * bank run (ppl withdrawing funds) leads to decreased supply of funds to lend. Leads to higher interest rates: increases in uncertainty. Makes it hard for lenders to screen good from bad credit risks (adverse selection) * lenders less willing to lend --- decline in lending, investment, and aggregate economic activity: increases in interest rates.
