Deflation, Central Banks and Financial Markets

Deflation,Central Banks and Financial Markets

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Deflation,central banks and financial markets

Bernanke’s&nbspspeechhighlights a high inflation rate as the predominant cause of thefinancial crisis. Bernanke points out in his speech that highinflation rates bring about increased lending by banks and otherfinancial institutions to borrowers interested in investing inindustries making huge profits because of high inflation rates. Thistrend encourages banks mainly in the private sector and otherfinancial institutions to irregularly give out loans to borrowers whoeventually are overburdened by their debts and fail to pay. Theresult of such a trend is the collapse of financial institutions,which brings deflation. Bernanke was making this speech back in theyear 2002, when the US economy could be described as stable since theinflation rates were low meaning hence no fears of deflation.

Accordingto Bernanke (2002), the main cause of deflation is the generaldecline in prices. When the price of a commodity falls, the demandgradually goes high. This causes the price to go high resulting frominflation (Pezzuto,2013).In his speech, Bernanke warned of a problem in the future, the dangerof deflation. Just as he predicted, the US faced a huge problem in2008, financial crises. The 2008 financial crises were mainly causedby the private sector’s drive for short-term profit. In 2006, thepricing for real estate housing went down and as a result attractedso many investors. These investors turned to banks for loans and thebanks, especially in the private sector generously gave out loanswithout proper regulations in order to make profits. Financialinstitutions gave out these loans almost freely on the theory thathousing prices would continue going high hence, the borrowers wouldmake huge profits adequate to allow them service their huge loanswithout any difficulties. However, housing prices suddenly went anddemand soared, as many people were unable to maintain theirmortgages. In fact, the high prices meant that many people could notpay their huge loans to the banks. At this point, the banks wererunning on major losses, hence had no capability to lend leading toslow economic growth and high rate of unemployment. Many banks andother financial institutions were at the point of closure when thenational government stepped to bail them out.

Bernankecould not see a probability of deflation occurring in the UnitedStates since the nation’s economy was stable and the bankingsystems seemed healthy and well-regulated. What he did not see was atthe time was the sudden decline in the housing industry which wouldbring major financial crises which would not only affect the UnitedStates, but the world at large. Patterson&amp Koller (2011)support Bernanke by pointing that one of the major causes offinancial crises is unregulated lending by financial institutions. Inthis regards, the US and other nations have cultivated fiscal andmonetary policies to stabilize the economy in the wake and aftermathof the crises. Since the 2008 financial crises, the Federalgovernment has implemented policies, which govern and regulate thecentral bank and other banks in terms of lending and borrowing. Inhis speech, another strategy used in preventing financial crises isby government ensuring that the inflation rate is not suppressed tozero since this will lead to a deflation, which finally results infinancial crises.

References

BernankeB.S. (2002). Deflation:Making Sure &quotIt&quot Doesn`t Happen Here. Retrieved from 16February 2015 athttp://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm

Patterson,L.A., &amp Koller, C.A (2011). Diffusion of Fraud ThroughSubprimeLending: The Perfect Storm. In Mathieu Deflem (ed.)&nbspEconomicCrisis and Crime&nbsp(Sociologyof Crime Law and Deviance, Volume 16), Emerald Group Publishing,pp.&nbsp25–45.

Pezzuto,Ivo (2013).&nbspPredictableand Avoidable: Repairing Economic Dislocation and Preventing theRecurrence of Crisis,Publisher: Gower Pub Co New edition