Ongoing Financial Crisis and the Prospect of Canadian Dollar

Ongoing Financial Crisis and the Prospect of Canadian Dollar

Financial crisis is a situation whereby all the institutions of finance suddenly lose their big part of value. It was associated by banking panics, stock market collapses, economic recessions, financial bubbles and the collapse of the currencies. There are various financial crises and these include banking crisis, speculative bubbles, international financial crisis and wider economic crises. It is expected that the government of the United States will keep their interest rates lower in the near lifetime at the end of this year. The Canadian bank and other major banks also opts to go slow in order to overcome the problems of financial crisis.

The output growth of the Canadian is expected to remain for about 3% in this year. According to the financial analysis report, the United States seems not to do much better regardless of delays in addressing massive financial shortfall. The major developed countries are intended to go for another year of recuperation and repair. Some developing countries such as china are expected to grow for a certain percentage increase. The new and emerging markets will therefore become more essential to the Canadian executives in the next decade. This will be inevitable incase the United States will lower their interest rates in the world market.

Causes and Impacts of Financial Crisis

            Various factors directly and indirectly cause financial crisis. According to the report on financial crisis from 2007 to 2010, many experts laid emphasis upon particular financial crisis. The financial crisis is a result of economic, financial, political and the interests of the organizations, which are complex and interdependence (Kaufman, 2008).The root cause of financial crisis is the deficiencies problems in the financial system especially in the developing world. There are other causes of financial crisis that are results of fragile fiscal systems such as complex financial securities, short- term dependence on market funding techniques and regional trade imbalances. Some causes such as high levels of consumer’ debts increases the stress of the fragile organization.

In addition, the above causes have an impact on the on going financial crisis such as failures of the essential financial organizations. Others represent a shocking stress on the system. Some causes are results of market failures such as stock market problems whereas others are due to global economic issues. These entire cause have an impact on the on going financial crisis because they discourage the investors in certain country thus leads to slow down of economic services. In most cases, some investors may have incentives to coordinate depending on their choices. For instance, investors may want to buy more dollars and expects the value of the dollar to rise, and thus has an incentive to purchase for the dollar too. The same case, a depositor who expects his fellow depositors to withdraw their money may expect failures from the bank and thus has to withdraw incentives too. This can affect the financial markets thus the financial institutions may end up losing their financial values. Financial crises are sometimes like a vicious circle because it keeps changing and what others do expects it to be done by others too.

Some factors contribute to financial crisis including strategic complementarities. This requires the successful investors to follow what others do in the market. It   requires other investors to compare what other investors do in the market and follow the same procedure. Incase certain investors lowers their incentives, they expects other investors to do the same in order to match the market prices (Kranjec, 2008). However, this creates an impact on the financial policy because self-fulfilling prophecy will result making other not to benefit but suffer from the loss while carrying out their business transactions. Consequently, leverage that is borrowing of finances is one of the greatest contributors of financial crisis. For instance, when certain financial institutions invest their own money, they may sometimes end up losing their own money on the same time. However, incase they borrows and keep investing more, they may end up earning more from the investments. Sometimes they may continue to lose more money in the process of investing their own money.

Another factor that cause financial crisis is an asset-liability mismatch. This is a situation whereby the associated risks of the debts and assets of an institution are not aligned properly. For instance, some banks such as commercial banks may offer deposit accounts to executives and homeowners that may be withdrawn at a certain period. Therefore, they may use the proceedings to create long-term loans. The mismatch will arise when the bank creates the short term and long-term loans. This is one of the reasons financial institutions may experience the problem of financial crisis resulting to slow development in an economy. Thus, debts and assets of an institution should be aligned in order to create balance thereby avoiding associated risks.

Monetary and Fiscal Policies taken in Response to Financial Crisis

 The monetary and fiscal policy makers reacted toward the financial crisis through formulating policies and measures for financial crisis management. Monetary policy is the process of controlling money supply in the country. The policies are set in order to target the interest rates in order to promote economic growth. The process can either be expansionary where the policies targets to increase money supply in the economy. It can be contractionary whereby the policies will be set to reduce too much money supply to avoid inflation in the economy. The objectives aim to stabilize prices and reduce unemployment level (Stark, 2009).

There are various monetary tools used to curb the problem of financial crisis. These tools include reserve requirements whereby the government may exert pressure on central commercial banks to reduce lending out money. This will reduce too much supply of money in the economy. Another one is monetary base whereby the central banks may be required to use open market operations in order to change the monetary base (Suetin, 2009).The central banks will be forced to sell their asset usually bonds to the public and they can use the fractional reserves to expand the circulation of money in the economy by larger amounts. Consequently, the interest rates can be used in reducing money supply by increasing indirectly nominal rates. Many nations have various methods of controlling the interest rates in the economy. For instance, the Canadian government sets the discount rate, which posses a significant effect on market interest rates.

A fiscal policy is whereby the government uses policies that influence macroeconomic conditions. The policies usually are designed to affect the tax and interest rates as well as the governments’ spending power thus controlling financial crisis. It is the use of taxes and government spending to influence the economic activities in order to stabilize the economy. The instruments used in this case are taxes and government expenditures. They use fiscal policies, which influences aggregate demand in order to attain price stabilization and full employment in the economy. Some theories such as use of Keynesian economic policies requires the government to increase spending powers and decrease tax rates for stimulating economic aggregated demand. Budget surplus can be used by the government to slow the speed of economic growth and stabilize prices incase of inflation.

The current financial crisis led to increase of the governmental efforts to curb this problem in the economy. The involvement of government in restricting bank and other financial institutions plays a greater role in overcoming the crisis. While the global economy continues to face critical financial crisis, the European Central Bank in line with the economic developments globally expects the economy to contract by a certain percentage. The global economy expects the financial crisis to return to gradual recovery and the projections indicates that the economy is underway to recovery because of the strong financial policies that will be formulated. The research report indicates that global price increases have continued to reduce rapidly because policies such as lowering prices for commodities and market prices restrictions (Stark, 2009).

Change in Exchange Rates in the Recent Years

            An exchange rate is the rate at which a certain country’s currency can be exchanged for another. It is the value of one currency of the country in relation to another currency. Exchange rates in the recent years created a powerful influence on the economy and the effect took quite some period to end. The rise and fall of the currency can quite take short period or long period depending on different variables such as inflation, Gross Domestic Products, exports and imports rates. In January 2002, the Canadian dollar was 61.79 and it increased in the recent years. In September 2007, the dollar increased tremendously unlike the earlier years. The exchange rate of the US dollar was 60 per cent cheaper than it was in 2002.

In addition, the top banks in Canada are not ready to quit from the floating exchange rates that they both with the United States have had from the previous years. The flexible exchange rates require the Canadian to maintain close production to achieve full capacity and reduce the negative effects that may arise. By the end of April 2008, the Canadian bank had already reduced lending rate to three per cent. The correspondent US rate reduced to 2.25 per cent while the central government attempted to ward off recession (CBC News, 2008). The Canadian interest rates are usually determined the level of interest rates in the United States. Consequently, they are determined by the rate of inflation and relative monetary policies in both countries. Thus, the rates cannot be higher or lower than that of the United States, which has never been fully independent.

The stabilization policies are linked with the exchange rates because the central government tries to use certain policies and exchange rate models to reduce financial crisis. The government may use policies such as the use of aggregate demand, market forces of demand and supply (Agarwal, 2011) to stabilize prices in the economy. In stabilizing the economy, the government will be forced to balance imports and exports rates in order to reduce regional trade imbalances. The central bank may introduce policies of market pricing to a specific level in order to control upward and downward movements of price in the market.

One of the exchange rate models that support the above explanation is the balance of payment model. This model is attached to the exchange rates basing on the aggregate imports and exports of a certain country. For instance, a country’s trade deficit will decrease in relation to its foreign reserves. Its currency value may depreciate too because of using this model. Thus, the cheaper currency may make exports to be more profitable and the imports will in turn be more costly. This will result to slow down of exports and rise on export. Hence, the result is stabilizing of trade balance and exchange rates.

Another model that supports the above explanation is the free-floating and pegged models. The central bank may decide to stabilize exchange rates of their local currencies through use of free-floating model. They can allow their exchange rates to vary in respect to those of different countries’ currencies based on the demand and supply market forces (Agarwal, 2011). On the other hand, they can employ use of pegged currency model by fixing their local currency at a fixed rate against the leading currency at a certain exchange rate. The central bank will then be responsible in marching the demand and supply of other countries’ currencies in order to stabilize exchange rates. The reason for using these models is to control financial crisis in the economy thus creating a stable financial economy.

 

 

References

Agarwal, V. (June, 05, 2011). Currency rate movements impact investments. The Economic

Times. Retrieved from http://articles.economictimes.indiatimes.com/2011-06-05/news/29623241_1_currency-exchange-rates-movements

CBC news (April 22, 2008). Interest rates: What you need to know about the cost of money.

CBC News. Retrieved from http://www.cbc.ca/news/background/economy/interestrates.html

Kaufman, H. (January 01, 2008). The financial crisis: Causes and remedies. Vital Speeches of the

            Day, 74.

Kranjec, M. (January 01, 2008). International financial crisis and bank performance. Banks in

Dire Straits.

Stark, J. (June, 08, 2009). The economic crisis and the response of fiscal and monetary policy.

European Central Bank. Retrieved from

http://www.ecb.int/press/key/date/2009/html/sp090608.en.html

Suetin, A. (January 01, 2009). Causes of the Current Financial Crisis. Problems of Economic

            Transition, 52, 3, 44-58.