Question 1

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 refers to a situation where a reduction in the aggregate price level reduces the net worth of firms, making it harder for them to pay their debts and resulting in a downward spiral of economic activity. This can stall a recovery from a recession. Moral hazard refers to the tendency for people to take on more risk when they are insured or protected against losses. Insolvency refers to a situation where a firm or individual is unable to meet their financial obligations. Illiquidity refers to a situation where a firm or individual is unable to access the funds they need to meet their financial obligations due to a lack of cash or other liquid assets. While all of these concepts are related to the financial health of firms and individuals, only debt deflation specifically refers to the situation described in the question.

Question 2

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

Bank panic is usually a symptom or a consequence of a financial crisis rather than its initiating cause. It can be triggered by other events such as a stock market decline or an increase in uncertainty. The other options, however, can be potential triggers of a financial crisis. For example, an increase in interest rates can lead to defaults on loans and a contraction in economic activity, which can in turn trigger a financial crisis. A stock market decline can erode investor confidence and trigger panic selling, which can in turn exacerbate the crisis. An increase in uncertainty can lead to a flight to safety, which can trigger a liquidity crisis and a credit crunch.

Question 3

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

The scenario described in the question is that of debt deflation, where a decrease in prices leads to an increase in the real value of debt, causing a decrease in firms' net worth. This can lead to a vicious cycle of further price reductions, debt burden increasing, and net worth deteriorating, ultimately resulting in a prolonged economic downturn. Asset bubbles are characterized by rapidly rising prices of assets, rising interest rates are an effect of inflation or central bank policy, and financial recovery indicates a positive economic situation.

Question 4

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

Accepted Answer

Unanticipated declines in the price level can cause deflation, which can lead to decreased spending, decreased investment, and decreased profits for businesses. This can result in a decrease in the overall health of the financial system. Increases in net worth, decreases in interest rates, and unanticipated increases in the price level can all have positive effects on the financial system, rather than worsening conditions.

Question 5

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

Accepted Answer

If debt contracts are of fairly long maturity, an unanticipated decline in the aggregate price level will result in a decline in the value of the collateral assets held by the borrower, leading to a decline in their net worth. This decline in net worth can lead to an increased risk of default and therefore decreased willingness to lend in the future.

Question 6

A(n)________ is an increase in prices of assets above their fundamental economic values.

Accepted Answer

An asset-price bubble is a situation where the prices of assets rise above their fundamental economic values, leading to an unsustainable increase in prices. This can be caused by various factors such as speculation, a surge in demand, or excess liquidity in the market. It can lead to a sharp correction in prices, which can have severe consequences for the economy. A decrease in moral hazard is a reduction in the willingness of individuals or institutions to take risks due to the removal of incentives or increased penalties. A decline in lending is a situation where there is a decrease in the availability of credit or the amount of credit extended. A liability war is a competitive situation where firms or individuals engage in the transfer of liabilities to others in order to minimize their own risks.

Question 7

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, when investors are unsure about the future direction of the economy and financial markets. This can lead to a lack of confidence and a sudden withdrawal of funds from the financial system, triggering a crisis. Recessions and stock market crashes are also often characterized by high uncertainty, which may contribute to the onset of financial crises. Low interest rates or low asset prices may also contribute to financial crises in certain circumstances, but they are not as consistently associated with crisis outbreaks as high uncertainty. High financial regulation is unlikely to be a contributing factor to financial crises, as regulation is intended to prevent them from occurring.

Question 8

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

An unanticipated decline in the price level increases the burden of debt on borrowing firms as the real value of their debt increases, but it does not raise the real value of their assets. As a result, net worth in real terms declines, which means that the firm's liabilities exceed its assets, and it is in a weak financial position. This could lead to default risk and reduced access to credit. Adverse selection and moral hazard problems are not related to this scenario, and there is no reason to expect an increase in lending.

Question 9

Debt deflation occurs when ________.

Accepted Answer

Debt deflation occurs when an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness. This can lead to a vicious cycle where falling prices lead to decreased spending, which in turn leads to further price deflation and potentially widespread bankruptcies.

Question 10

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

Accepted Answer

This sequence is commonly observed in financial crises, where asset prices (such as housing prices) decline, leading to banking crises as financial institutions are heavily invested in these assets. The banking crisis can then lead to an unanticipated decline in the price level as credit and lending freezes, resulting in a recession.

Question 11

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

Accepted Answer

The answer of The start of a recession or a...

Question 12

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

Iceland's banking system collapsed in 2008, requiring the government to take over its three largest banks. This led to a deep recession in the country.

Question 13

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, a situation in which falling prices and declining asset values cause borrowers to default on their loans, can lead to a vicious cycle of economic contraction. As more borrowers default, banks' balance sheets deteriorate, leading to further credit tightening and more defaults. This can lead to a severe contraction in economic activity, as was seen during The Great Depression. The other choices do not contribute to adverse selection or moral hazard problems in credit markets, which are a key factor in exacerbating the effects of a recession.

Question 14

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

Accepted Answer

Uncertainty about banks' health can lead to a loss of confidence in the banking sector, causing depositors to withdraw their funds from banks en masse. This can lead to a devastating banking crisis where banks fail, resulting in a domino effect on the economy with cascading bankruptcies, unemployment and deflation.

Question 15

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 as banks become more hesitant to lend out money. This can in turn lead to a decline in productive investment and ultimately a contraction in economic activity. While international trade may be affected by a bank panic, it is not necessarily the primary cause of economic contraction. Bank shareholders may lose money, but this does not directly impact economic activity. Bank depositors may also experience losses, but this may not have as significant of an impact on economic activity as the decline in lending.

Question 16

A sharp stock market decline increases moral hazard incentives ________.

Accepted Answer

A sharp stock market decline can lead to a decrease in the value of assets held by firms, making them more likely to default on loans. This creates an incentive for firms to take on riskier investments as they have less to lose. This is known as moral hazard.

Question 17

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

An unanticipated decline in price level alone is not likely to be the initiating cause of a financial crisis. While it may have negative effects on certain markets, it is typically not enough on its own to trigger a widespread crisis. The other options (increase in interest rates, stock market decline, increase in uncertainty) are all more likely to have a greater impact on the stability of the financial system.

Question 18

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 issue short-term commercial paper to finance their holdings of longer-term assets.

Question 19

The Irish government helped mitigate the financial crisis by ________.

Accepted Answer

The Irish government guaranteed all deposits, which helped reassure citizens that their money was safe in the midst of the financial crisis. This measure helped prevent a run on the banks and stabilized the financial system to some extent.

Question 20

Banking crises or bank panics have started when ________.

Accepted Answer

Banking crises or bank panics usually start when depositors begin to lose confidence in the banking system and withdraw their funds from banks, causing a liquidity problem for the banks. This can trigger a cascade of bank failures as the banks are unable to meet their obligations to depositors and creditors. Therefore, choice C is the most accurate option.

Quiz 9: Financial Crises

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

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?

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 ________.

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

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

A(n) ________ is an increase in prices of assets above their fundamental economic values.

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

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 ________.

Debt deflation occurs when ________.

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

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

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 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.

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

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

A sharp stock market decline increases moral hazard incentives ________.

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?

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 ________.

The Irish government helped mitigate the financial crisis by ________.

Banking crises or bank panics have started when ________.