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Credit Crunch Overview • Current crisis is more than a credit crunch in Ireland • 4 Aspects or causes with effect on AD – Asset market Bubble: I – Government Budget: G – Banks: C+I – International Credit Crunch: C+I, NX • Solutions – General: shift in AD – Special: unusual aspects of current crisis Bubbles • Bubbles can occur in asset markets in general – US, UK, Ireland have housing market bubble • Examine evidence to prove this – Obvious now but clear signs before: Not just a price increase – Soft landing • Psychology – Shiller “Irrational Exuberance” – Makay “Madness of Crowds” • Consequence was huge Investment (20% GDP) – GDP Boom – Inv cut-off: huge shock to AD Budget • We have already seen how budget went from surplus to deficit • Bubble generated boom covered up a huge underlying deficit – Evidence of the structural position • A fiscal contraction now makes things worse – Shift AD to left – EFC? Discretionary changes in taxes and expenditure NT2 Natural GNP G, NT NT 1 NT 3 € billions B GNP 1 A C GNP * GNP 2 Government expenditure (G) Nominal GNP Leddin and Walsh Macroeconomy of the Eurozone, 2003 Banks • Massive amounts of foreign borrowing – Through banks to housing market • Weakens banks – Highly leveraged: lots of assets, lots of liabilities; small cushion – Asian currency crisis: Iceland vs Ireland – US: Shadow banks • Banking crisis is another shock to economy – Shortage of funds (controversial) Credit Crunch • Originated in the US not Ireland • Direct Consequnces – Hit directly two major markets for our exports (NX) – Rise in interest rates (C+I) – Would have burst bubble anyway • Makes dealings with with our banks more difficult – – – – Government guarantee Borrow for deficit Borrow for banks Fear of upsetting bond markets Overview of the Overview costs Foreign Borrowing Banks Inv budget NX