Importance of investigating financial weakness

Author: Iloka Benneth Chiemelie

Published: 8/12/2013

1.0 Analyse the techniques and assumptions used by the authors to investigate the importance of financial weaknesses and linkages in the three crises described.

The authors based on their investigations on previous researches by presenting discussions of the techniques as:

1.1 Common shock – it was noted that the occurrences of currency simultaneously can be as a result of the interaction of common shocks with the macroeconomic fundamentals. A good example was presented in the case of the appreciation of U.S dollar during the 1995-97 and weak growth of the Japanese economy in the 1990s as having a direct influence on the weakening of the external sector in numerous Asian economies. The basic implication is that when two economies are integrated together, changes in currencies (appreciation or depreciation) might have direct influence on the performance of other economies that they are integrated together with.

1.2 Trade linkages – this is still similar with the view presented in common shock above. The idea in view with respect to this case is that when two economies are integrated together, if one of the economies experiences depreciation in its currency, it would result to a subsequent trade spill over in the other country as it would not be able to make purchases for the same amount of goods with the same amount of cash like it used to in the past.

1.3 Financial linkages and shifts in investment - a simple summary of the ideology presented in this linkage is that when a country is experiencing currency crisis, it can result in the contagion of investors selling their most valuable assets and investing it in countries with higher potential for returns, which will lead to further financial issues in the crisis economy.

2.0 On the basis of the evidence presented, how convincing is their conclusion of the following: ‘The common creditor is the most important and significant variable, and provides an economic explanation for the regional concentration of crises’?

The authors defined a common creditor as the lender who makes available the necessary financial aid needed to establish financial stability in another country. On a region specific ground, the common creditor is well known for such functions based on integration of its economy with that of other economies in the region and continuous support for ensuring financial stability in that region. For instance, Japan and China are common creditor in the Asian region, while USA could easily be described as a global common creditor and without a doubt a common creditor in the North American region.

The authors made known that common creditors are very important, robust and significant variables. This is because the variable represents more than half of the power of the benchmark regression and jointly functions with reduced output growth, providing the largest contribution on the potentiality of a new crisis to emerge or an existing one to escalade.

This is very much convincing based on the understanding that common creditors have been seen in these region as “crisis blocker,” or a kind of “help me now friend” with high chances of responding to such calls in the region. Taking for instance the case of Germany (a common creditor) try to block the escalation of financial crisis in the EU by supporting the Greece bailout and other huge bailouts in the region, it can be seen that they are always depended upon by the crisis nation when such financial crisis occur. On that account, if the common creditor doesn’t respond to the crisis significantly and on time, it can easily be seen that the crisis will remain in the region (EU – Greece for example) and escalade uncontrollably. As such, there conclusion is very convincing because growth (both business wise and GDP of a nation) can easily be affected without the supports of common creditors and crisis can escalade in the region without such supports. This is the underlying elements that made the authors describe “common creditors” as “significant” with respect to “regional economic crisis.