Have finacial markets lost faith in politicain ability to handle their economies

Sunday, 28 August 2011

Have finacial markets lost faith in politicain ability to handle their economies

Question no. 62

Have financial markets lost faith in politician’s ability to handle their economies.

 INTRODUCTION 

 Financial Market:-

Broad term describing any market place where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade.

Some financial markets only allow participants that meet certain criteria, which can be based on factors like the amount of money held, the investor’s geographical location, knowledge of the markets or the profession of the participant.

Discussion

The role of political environment in financial development is considered through several channels: how the political connectedness of managers affects firm valuation and ease of raising capital; the way politicians influence banks (and other companies) trying to attract electoral support; the ability of interest groups with political power to shape financial market institutions.

In the early stage of financial system development, the financial market is relatively small and the optimal configuration is for there to be a few banks in the economy. Politicians intervene to expand credit availability to borrowers by providing direct capital subsidies to banks in exchange for some state ownership of banks. In the intermediate stage, the financial market is larger and the optimal configuration involves more banks in the economy, with each being bigger. There is no political intervention in the financial system.

In the advanced stage, the financial market is at its largest and the optimal configuration has even more banks, with each being larger. Political intervention returns, this time in the form of direct-lending regulation that mandates that banks make loans to low-quality borrowers, even if doing so imposes losses on banks. Thus, the relationship between political intervention and financial system development is non-monotonic, and politicians intervene when financial markets are underdeveloped or highly developed.

Politicians cannot come to an agreement on the debt ceiling, what economic consequences should we expect?

If Politicians Do Not Reach Agreement

If politicians fail to reach a deal to increase the debt ceiling, there would be a large fall in federal spending. The decline in federal purchases of private sector goods and services would reduce aggregate demand, and this could slow or even reverse the recovery (it could also threaten the delivery of critical services that some people depend upon). In addition, the failure to pay wages to federal workers would disrupt household finances and cause a further decline in demand, as would the failure of the government to pay its bills for the goods and services it has already purchased from the private sector (and it could even threaten some households and businesses with bankruptcy should the problem persist).

If Politician Reach Agreement

It depends on the nature of the agreement. If the immediate budget cuts are large and poorly targeted, the resulting impact on the economy could threaten the recovery. Those who favor large and immediate cuts argue that the increase in the confidence of investors will more than compensate for the decline in demand.

The best outcome of the negotiations over the debt ceiling would be for both sides to agree upon a credible framework for reducing the debt level over time (which must include tax increases). That would give investors the confidence they need that politicians will be able to solve the debt problem without threatening the economic recovery or harming long-run economic growth.

The past behavior of politicians and the lack of credibility on budget issues, faith in politicians are so low that any agreement about the future will likely be discounted substantially. This means politicians need to show people that they are serious about the debt Problem by making large, immediate cuts -- promises are not enough -- and we could be headed for slower growth of output and employment, or even outright declines.

CONCLUSION

According to the discussion above the faith of financial market in politician ability is losing due to the slow performances and public response to the financial market. Politicians need to show people that they are serious about the debt Problem by making large, immediate cuts -- promises are not enough.

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Submitted to: Prof. Gurdeepak Singh
Submitted by: Nitika Lamba (MBA I-C)