Answering Economic Questions
With increased economic integration between nations and advancements in technology in the last couple of decades, economies across the globe have become more interconnected than never before. Economists believe that an inclusive and dynamic global economy is essential to meet the ambitious UN targets of the 2030 Agenda for Sustainable Development. However, because of the interconnection and interdependence of various economies, any shock in a given country may have a significant effect on the global economy, for instance, the COVID-19 epidemic. According to (United Nations, 2020), the global economy has witnessed a significant broad-based deterioration over the past years amid the prolonged trade. The situation is likely to threaten the achievements that have already been made to reduce poverty, increase job creation, and broaden individuals’ access to affordable and cleaner energy.
According to the UN, the deterioration in the global economy is exhibited by a sudden drop in the world gross product to 2.3% in 2019. This is the lowest rate since the 2008-2009 global financial crisis, and the figure was projected to rise to 2.5% in 2020. The author further reiterates that such slowdown in the economic growth of the global economy was occurring at a time when pervasive inequalities and deepening climate change crisis have also become serious issues of concern. In 2019, there were a series of global trade tensions which saw the US and China taking the forefront to coerce one another into agreeing with their trade terms. However, even as such global trade tensions ease, there is no doubt that the potential for relapse of these trade wars is still high since the underlying issues associated with these disputes are yet to be tackled in depth.
Currently, the global economy is suffering massively from the COVID-19 epidemic which has seen most countries such as the US and China significantly projecting their economic forecast downwards due to low economic activities in the last three months. According to (Carlos-Szlezak, Reeves, and Swartz, 2020), the COVID-19 pandemic is inflicting adverse economic effects, and the necessary protection measure, including lockdown, which is being adopted by most governments are severely impacting the overall global economic performance. The author states that as a result of the epidemic, the global economic performance is expected to decline by 3% in 2020, which is much worse if compared to the 2008-09 financial crisis. China, which was once the epicenter of the coronavirus, appears to be turning a corner. However, even as the number of the local transmissions is on the minimum and daily life of its citizens returning to normalcy, there is no doubt that the virus has hard hit the economy. With the quarterly rate of Chinese growth steadily edging down since 2017, and its economic growth rate decreasing in the last three years, it is correct to argue that the next two years will be even worse for China. The US economy has also been affected significantly by the virus, and today it leads to the number of deaths and local transmission rates. The country’s future economic outlook also looks wanting as the economic growth projects for the next three years are being projected downwards.
According to (Downey, 2020), efficient market hypothesis, also known as efficient market theory, states that prices of stocks always reflect all the relevant information, and therefore, consistent alpha generation is likely impossible. The theory is postulated on the paradigm that stocks will always trade at their market value on exchanges, thus making it impossible for investors to purchase undervalued stocks or sell stocks at inflated prices. The pros of the efficient market hypothesis include acting a standard arena for good financial investment decision, provides an array of knowledge for clients advising. It also acts as a capital market research in accounting and also provides legal evidence to establish claims for damages based on the disclosure of financial reports. The cons of the efficient market hypothesis are that it increases investors’ confidence in their ability to predict future fluctuations in stock prices or corporate earnings which results in them making huge financial losses from their investments.
On the other hand, behavioral finance is the study of a person’s investment behavior and decisions as influenced by his psychological, cognitive, cultural, emotional, and social factors. The behavioral finance theory contradicts the efficient market hypothesis by arguing that investors are not always rational in making their investment decisions because they have limits to their self-control which influence their biases. Unlike the efficient market hypothesis which postulates that both market and investors are perfectly rational and that the latter have perfect self-control in their investment decisions, behavioral finance theory, however, states that investors can be confused by cognitive errors or information processing errors which would lead them into making wrong financial investments.
One issue that been a major of concern for investors and policymakers in the global financial system is whether a financial market is indeed efficient to allow investors to make sound and informed decisions when it comes to purchasing of stocks. Decades ago, the efficient market hypothesis was viewed and widely accepted as the best premise of analyzing stock market performance (Gupta, Preetibedi, &Mlakra, 2014). Financial economists believed that securities markets were extremely efficient in reflecting the accurate information about the stock prices. They argued that when new information arises, the financial market will act efficiently by ensuring that all the investors receive such information in time and at no cost. They, therefore, assumed that the financial markets would not experience any externalities. However, the occurrence of the 2008-2009 global financial crisis proved these assumptions otherwise.
The derivatives Markets play in contributing to the Global Financial Crisis of 2008-2009. During the 2003-2007 period, the derivatives were established with the intention of defending investors against risk and offering protection against the fluctuation of stock prices. However, these derivatives became speculative tools and were used by commercial banks and other investors to take on more risky investments with the view of maximizing profits and investment returns. Because there were fewer credit-worthy customers to lend, commercial banks turned to subprime borrowers, thus establishing securities with poor underlying credit-quality loans. The impact of this was the significant fluctuation in prices of stocks in the US, a crisis whose impact was later felt across the globe leading to the global financial crisis in 2008-2009.
Q4. What is wrong with the Euro? Why was it created despite known imperfections?What solutions are available?
The European Union remains one of the successful economic integrations in the modern world. Formally established in November 1st, 1993, when the Maastricht Treaty was formed, the Union comprises of 27 member states which were primarily located in Europe. Six years later, after the formation of the Union, the euro currency was introduced. Initially, the euro currency was used for exchange between European Union countries, while the people within each country were allowed to use their respective local currencies. Three years later, the member countries agreed to replace the various domestic currencies with the Euro, which now became the everyday currencies. Even though the euro currencies provided several economic advantages including easing the burden of travel by removing the need for individuals to exchange money in case they were travelling from one country to another, its creation is also viewed as the causes of economic crisis facing most EU members such as Greece, Portugal, and Ireland.
The current political and economic quagmire that has marked the EU, which is evident from the bailout of Greece and Portugal, and the recent withdrawal of Britain from the Union, thrushes Winston Churchill’s vision of a United State of Europe (Peston, 2012). These problems can be traced back to the creation of the euro currency which was done without considering the monetary ramifications or even establishing the much needed set of institutions that could enable the currency to function effectively. It is evident that the leaders who were at the forefront to call for the creation of the single currency were not aware of the Friedman’s near-theorem on the prosperity and limits of monetary policy. Friedman Milton, one of the renowned economists of the 20th century, argued that monetary policy cannot help an economy raise its long-term growth prospects but is only applicable in stabilizing the economy in case of economic shocks.
According to (Mody, 2018), the use of a single currency meant that if a member country goes into recession, it would lack the domestic currency to devalue in order to re-engineer the economy and boost employment and exports, which would definitely become cheaper due to the devaluation of the local currency. The solution, therefore, is for EU countries to return to their previous national currencies or opt for closer integration to give the current monetary system the much needed political structure to work.
Behravesh, N. (January 04, 2019). 10 predictions for the global economy in 2019.World Economic Forum. Retrieved from https://www.weforum.org/agenda/2019/01/what-to-expect-for-the-global-economy-in-2019/
Carlos-Szlezak, P., Reeves, M., and Swartz, P., (March 3, 2020). What coronavirus could mean for the global economy. Harvard Business Review. Retrieved from org/2020/03/what-coronavirus-could-mean-for-the-global-economy“>https://hbr.org/2020/03/what-coronavirus-could-mean-for-the-global-economy.
Gupta, E., Preetibedi, P. O. O. N. A. M. L. A. K. R. A., &Mlakra, P. (2014). Efficient Market Hypothesis V/S Behavioural Finance.IOSR Journal of Business and Management, 16(4), 56-60.
Mody, A. (September 3, 2018). Why the Euro failed. Quartz. Retrieved from https://qz.com/1377098/why-the-euro-failed/
Peston, R. (2012). The Great Euro Crash.ThoughtMaybe. Retrieved from https://thoughtmaybe.com/the-great-euro-crash/
Stiglitz, J. (August 10, 2016). The problem with Europe is the Euro. The Guardian.Retrieved from https://www.theguardian.com/business/2016/aug/10/joseph-stiglitz-the-problem-with-europe-is-the-euro.
United Nations.(2020). World Economic Situation Prospects.
Zucchi, K. (June 25, 2019). Did derivatives cause the recession? Investopedia. Retrieved fromhttps://www.investopedia.com/financial-edge/0210/did-derivatives-cause-the-recession.asp
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