Question

Explain and discuss how each phase of the boom-and-bust cycle has characterized the history of capital flows from the advanced industrial countries to the developing world. Should national governments or international institutions regulate capital flows? How effective are capital controls? What is the role of the IMF in regulating cross-border capital flows

Answer 1

Answer:

The boom and bust cycle is a process of economic expansion and contraction that occurs one after the other. During the boom the economy grows, jobs are plentiful and the market brings high returns to investors. In the subsequent bust the economy shrinks, people lose their jobs and investors lose money.

Explanation:

Characteristics of Boom: Increases in demand for capital/consumer goods. Businesses tend to increase their investment, employment opportunities abound, Consumer confidence is strong and consumers have a positive outlook.

The bust periods are referred to as recessions; if the recession is particularly severe, it is called a depression.

Since the mid-1940s, the United States has experienced several boom and bust cycles. Why do we have a boom and bust cycle instead of a long, steady economic growth period? The answer can be found in the way central banks handle the money supply.

During a boom, a central bank makes it easier to obtain credit by lending money at low interest rates. Individuals and businesses can then borrow money easily and cheaply and invest it in, say, technology stocks or houses. Many people earn high returns on their investments, and the economy grows.

Yes, national government and international institutions should regulate capital flows because when credit is too easy to obtain and interest rates are too low, people will overinvest. This excess investment is called “malinvestment.”

When this happens, There won’t be enough demand and the bust cycle will set in. Investments will decline in value. Investors lose money, consumers cut spending and companies cut jobs. Credit becomes more difficult to obtain as borrowers become unable to make their loan payments.

The IMF controls cross border flows by promoting exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.