Macroeconomic Economic Causes

MACROECONOMIC CAUSES OF THE CRISES
The most important factors that contributed to the US housing bubble were low U.S. interest rates and a large U.S. trade deficit. Low interest rates made bank lending more profitable, while Trade deficits resulted in large capital inflows to the U.S. Both made funds for borrowing plentiful and relatively inexpensive.
The event that precipitated the crisis was the overvaluation of the United States housing market in 2006 and the subsequent crash. Housing prices were driven upwards by easy credit and over speculation on the belief in the false truism that housing prices always go up. Low initial rates on adjustable rate mortgages (ARM) and low down payment requirements encouraged short-term speculation with

The banks, according to this argument, could not have expanded their balance sheets in recent years without borrowing from abroad, which kept interest rates low, and allowed them to engage in riskier, higher-yielding assets which were facilitated by the financial innovations in advanced countries. These imbalances are not just due to US deficits financed by Chinese surpluses. While Europe has an overall current account balance, there are sharp differences within the region: the UK and Spain being large borrowers while Germany’s large current account surpluses fund the consumption of Southern Eurozone countries. The problems with global macroeconomic imbalances are two-fold: the absolute size of current account surpluses (and also deficits elsewhere) has expanded very rapidly, placing a severe burden on the financial systems which has to intermediate the capital flows. The surge of these imbalances is seen as the result of financial deregulation, since the removal of capital controls and advances in financial innovation allowed current account deficits to be financed. In fact, there were no current account imbalances in 1996. This changed in 2008 when the US current account deficit increased to $600 billion and the emerging markets plus developing countries’ current account surplus rose to $900 billion. Secondly, US flow of capital has been the wrong way: from poor countries to rich. Advanced countries have invested their surplus capital mainly in each other’s economies, instead of