Question 1

If debt contracts are of fairly long maturity, then an unanticipated decline in the aggregate price level results in ________.

Accepted Answer

If there is an unanticipated decline in the aggregate price level, it leads to deflation which increases the real value of debt obligations, making them more difficult to repay. This results in a decline in a firm's net worth as it becomes harder for the firm to meet its debt obligations, and the value of its assets may also decline due to the deflation.

Question 2

How do increases in interest rates play a role in promoting financial crises?

Accepted Answer

The answer of How do increases in interest rates play...

Question 3

A possible sequence for the three stages of a financial crisis in Canada might be ________ leads to ________ leads to ________.

Accepted Answer

The first stage of a financial crisis in Canada would likely involve a decline in asset prices, such as housing or stock prices. This could then lead to banking crises, as these institutions may have made loans based on the value of those assets. Finally, an unanticipated decline in the price level could occur, causing further economic trouble.

Question 4

The government bailout of troubled financial institutions occurred in the U.S. and many other countries. Which country saw their banking system collapse requiring the government to take over its three largest banks?

Accepted Answer

The collapse of the banking system requiring the government to take over its three largest banks occurred in Iceland.

Question 5

The start of a recession or a stock market crash can result in ________.

Accepted Answer

Low asset prices are a common result of the start of a recession or a stock market crash.

Question 6

An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms' assets. The result is ________.

Accepted Answer

When the price level declines unexpectedly, the real value of the assets owned by borrowing firms does not increase. This means that the real net worth of the firm declines while the burden of debt increases. As a result, the firm may face financial distress, making it more difficult for them to obtain future loans. Therefore, option A is correct. Options B, C, and D are incorrect as they do not reflect the outcome of an unexpected decline in the price level.

Question 7

A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called ________.

Accepted Answer

Debt deflation is a situation where a decrease in the aggregate price level increases the real value of debt, leading to a decline in asset prices and a decrease in net worth. This can cause firms to become less willing to invest or take on new debt, which can stall the recovery from a recession. Moral hazard is a situation where one party takes risks because they know another party will bear the costs if things go wrong. Insolvency is a state of financial distress where a firm is unable to pay its debts. Illiquidity is a situation where a firm or market is unable to find buyers for its assets, which can cause prices to decline rapidly. While insolvency and illiquidity can also contribute to a recession, they do not specifically refer to the process of a decrease in the aggregate price level causing a decline in net worth and stalling a recovery.

Question 8

A bank panic can lead to a severe contraction in economic activity due to ________.

Accepted Answer

A bank panic can cause a decline in lending for productive investment, since banks may become reluctant to lend due to fears of further losses. This can lead to a contraction in economic activity as businesses and individuals are unable to secure the funds needed for investment and spending. Losses of bank shareholders and depositors may also occur, but they do not directly impact economic activity in the same way as a decline in lending. Similarly, while a decline in international trade may be a consequence of a bank panic, it is not a direct cause of economic contraction.

Question 9

The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression.

Accepted Answer

Debt deflation led to a decrease in the overall price level, which increased the real burden of debt, causing defaults and further deflation. This created adverse selection and moral hazard problems in credit markets, leading to a contraction in lending and a severe economic downturn known as The Great Depression. Illiquidity, an improvement in banks' balance sheets, and increases in bond prices are not direct causes of the Great Depression.

Question 10

Banking crises or bank panics have started when ________.

Accepted Answer

Banking crises or bank panics occur when depositors start withdrawing their funds from banks in large numbers, leading to a liquidity crisis for the banks. This can cause a chain reaction of bank failures and have a severe impact on the economy. Factors that can trigger a bank run include rumors or news about the bank's financial health, loss of confidence in the banking system, or economic instability.

Question 11

If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) ________.

Accepted Answer

A banking crisis is characterized by mass withdrawals of funds from banks due to uncertainty about the banks' health. This can lead to a liquidity crisis and potentially bank failures, which can have significant negative effects on the economy.

Question 12

If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

Accepted Answer

While an unanticipated decline in price level can have negative effects on the economy, it is less likely to be the initiating cause of a financial crisis compared to the other options listed. Increases in interest rates, declines in the stock market, and increases in uncertainty can all have significant impacts on the financial sector and potentially lead to a crisis. However, an unanticipated decline in price level may not necessarily have a direct impact on the financial sector and would likely need to combine with other factors to initiate a financial crisis.

Question 13

A sharp stock market decline increases moral hazard incentives ________.

Accepted Answer

A sharp stock market decline typically indicates economic uncertainty, which can lead to lenders being more willing to make loans to borrowing firms. However, this also increases moral hazard incentives for the borrowing firms since they have less to lose if their investments fail.

Question 14

Most financial crises have started during periods of ________ either after the start of a recession or a stock market crash.

Accepted Answer

Financial crises often occur during periods of high uncertainty, whether it is uncertainty about the economy, politics or financial markets. This uncertainty can lead to a lack of confidence in the financial system, causing investors and consumers to panic and withdraw their investments, which further exacerbates the crisis. Therefore, A is the correct answer as it highlights the factor of high uncertainty which is usually present during financial crises.

Question 15

Factors that lead to worsening conditions in financial system include ________.

Accepted Answer

Unanticipated declines in the price level can increase the real burden of debt, leading to financial distress and worsening conditions in the financial system.

Question 16

Like a CDO, a structured investment vehicle pays off cash flows from pools of assets, however, rather than long-term debt the structured investment vehicle backs ________.

Accepted Answer

Structured investment vehicles typically back commercial paper, which is a short-term debt instrument used by companies for short-term financing needs.

Question 17

An economic downturn which causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness results in ________.

Accepted Answer

This situation is referred to as debt deflation, where a decrease in price levels leads to an increase in the real value of debt, making it harder for firms to pay off their debts and leading to a deterioration in their net worth. This can lead to a vicious cycle of further economic downturn and worsening of the debt burden. This is not related to asset bubbles, rising interest rates or financial recovery.

Question 18

Debt deflation occurs when ________.

Accepted Answer

Debt deflation occurs when an economic downturn causes the price level to fall, which increases the burden of indebtedness on firms and results in a deterioration in their net worth. This can lead to a downward spiral as firms try to reduce their debts, leading to fewer investments, lower demand, and further price decreases.

Question 19

If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

Accepted Answer

A bank panic would be a later event in the sequence of a financial crisis, typically caused by a preceding event such as a stock market decline or increase in uncertainty. The other choices could be potential initiating causes of a financial crisis.

Question 20

The Irish government helped mitigate the financial crisis by ________.

Accepted Answer

The Irish government helped mitigate the financial crisis by guaranteeing all deposits, which helped restore confidence in the banking system and prevented a widespread run on banks.

Quiz 11: Financial Crises

If debt contracts are of fairly long maturity, then an unanticipated decline in the aggregate price level results in ________.

How do increases in interest rates play a role in promoting financial crises?

A possible sequence for the three stages of a financial crisis in Canada might be leads to leads to .

The government bailout of troubled financial institutions occurred in the U.S. and many other countries. Which country saw their banking system collapse requiring the government to take over its three largest banks?

The start of a recession or a stock market crash can result in ________.

An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms' assets. The result is ________.

A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called ________.

A bank panic can lead to a severe contraction in economic activity due to ________.

The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression.

Banking crises or bank panics have started when ________.

If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) ________.

If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

A sharp stock market decline increases moral hazard incentives ________.

Most financial crises have started during periods of ________ either after the start of a recession or a stock market crash.

Factors that lead to worsening conditions in financial system include ________.

Like a CDO, a structured investment vehicle pays off cash flows from pools of assets, however, rather than long-term debt the structured investment vehicle backs ________.

An economic downturn which causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness results in ________.

Debt deflation occurs when ________.

If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

The Irish government helped mitigate the financial crisis by ________.