Custom «Financial Crisis» Essay Paper

Venezuela a country in South America mainly depends on the petroleum sector which accounts for almost a third of the country’s GDP and an estimated 80% of the country’s export. Venezuela is ranked fifth in oil production within the Organization of Oil Producing Countries (OPEC). During the past few decades, the Venezuelan economy experienced a steady rise in terms of economic growth but the growth was short-lived due to a collapse in oil prices in the mid 1980s. However, the Venezuelan economy constantly exhibits fluctuating figures in terms of growth and shortfalls. According to economic analysis, Venezuela has one of the world’s highest inflation rates with analyst putting the figure at 29.1% in the year 2009. Oil exports are the main foreign exchange earner in the country accounting for almost 80% of the country’s gross domestic product.

According to Knittel, the effects of the financial crisis which originally developed from the sub-prime lending is further compounded by worries of global inflation in the broader U.S. economy (Knittel 2007). The worries regarding global inflation are the main cause of the ineffectiveness of the stimulus package drawn by Fed in the beginning of the year. The origin of the crisis was as a result of lax lending in the property market which at the time was further fuelled by easy monetary policies in 2001. The speculation in the property market proved to be very disastrous for the U.S. economy. The approach taken by Fed at the time was to encourage low interest rates boosting consumer spending fuelled by low mortgage prices. This enabled a property boom that saw the U.S. register a record surge in house ownership. This in turn increased spending which further pushed housing prices up. This implies that instead of Fed averting one problem, it introduced an even greater problem.

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Inflation

Venezuela has the world’s highest inflation rates. Instead of eliminating and reducing undisciplined spending, the government and the central bank of Venezuela (Banco Central de Venezuela) encouraged another round of speculative spending. The world’s most sophisticated financial tool, the CDO was used to package and securitize mortgage loans and then sold to equity markets across the globe. The predications of Fed in the US and Venezuelan monetary commission were that as long as house prices maintained their stability or kept on rising, the housing bubble could not bursts and that the economy could survive on its indiscriminately spending. The government was also encouraged by home owners, central bank, speculators, lenders and investors implying that the continued borrowing by these parties would finance their spending.

This trend reached the height characterized by default rates becoming apparent and the wide-spread euphoria of a hike in house prices disappearing. The whole system of the mortgage lending and borrowing to finance spending eventually collapsed leading to an apparent economic crisis. The impact of the collapse of this system is not limited on the household income but spilled over to financial institutions and other government backed mortgage lenders such as Fannie Mae and Freddie Mac in the US.

Recession

Generally, the economy is facing a slowed growth momentum and a possible recession complicated further by global inflation. This is at a time when customers are facing financial difficulties leading them to cut on expenses due to high debt level and a reduction in value of the property assets. The purchasing power of consumers is further undermined by global inflation rates which have been mainly caused by depreciating dollar value. This creates a cycle of crisis leading to further erosion in the purchasing power of consumers as well as imported inflation. This raises the question whether the stimulus package by the government and the cut of interest rates by central bank will revive the aggregate demand which is the economic engine in current economic times.

What should Venezuela do?

During this time of economic crisis, the government should address economic policies that affect near and long term economic performance. One of the areas that the government can address is the tax policy. The government should signal today what it expects to do on taxes in some few years to come. Maintaining lower taxes encourage labor and capital leading to increased economic activities. Another area that the government should address is mortgage market regulation by not extending new subsidies in the housing sector. This is because, an efficient mortgage credit industry is central to the country’s economic future.

What Hugo Chávez should do?

Right now, the effectiveness of the stimulus package by the government is dependent to some extent by foreign power. According to Venezuelan monetary commission, easing monetary policies by fed would further cause increased inflation and increased recession. One tool which the government can use is change the reserve ratio. This will allow banks to lend less reducing the supply of money hence reduce inflation. The government can also reduce the money supply through open market operations. The interest rates play an influential role in the economy. The government’s signal regarding the rate of interest in the financial market will hence address consumer behavior as well as regulate spending.