plz help sove this problem about AD-AS, Macroeconomics Q. The given graphs show
ID: 1155274 • Letter: P
Question
plz help sove this problem
about AD-AS, Macroeconomics
Q.
The given graphs show changes in a housing price and credit spread after recent financial crisis (2007~2009). On the basis of these two graphs, expain the change in "inflation" and "output". Use AD-AS curve and write the reason these curves shift.
Explanation / Answer
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The housing crisis of 2007-2009 lead to change in demand for homes due to the mortgage crisis. In the above two graphs we can see shift of demand from high demand in the year 2006 to less demand in 2009 this occurred due to increase in the credit risk spread. In the year 2006 we can clearly see the housing market peak when the demand was in the range of 90 to 100 and in the year 2009 we can see that the demand fell down to arrange between 60 to 70 similarly the credit spread for the year 2009 was at its peak and in 2006 it was at its normal level below 2%.
We need to understand this phenomena of AD (average demand) and AS (average supply) curve.
Critically analyzing the two graphs-
The credit risk spread is the difference between the rates at which the banks offer to the retail customer compared to the rate at which they procure loans.
If we analyze the two graphs we will see that the demand for homes rising from the late 2004 to early 2005 that was a time when the spread was bare minimum because of which the banks were able to lend at a competitive rate and when the demand started rising the banks were offering loans at a very competitive rates and also the spread was normal.
It happened as the demand was rising year on year from 2006 to 2008 the lending also gained pace, if we see the supply of money in the economy rose supply of houses also went up.
This gave a situation where an average supply was higher than average demand. This scenario clearly indicates that they were abandoned houses to be financed at a cheap rate.
Applying concepts of human psychology, which means that things that are easily available have a chance of defaulting the most. Also a scenario coming up in the year 2009 when demand started falling. By this time banks have almost lent 90% of the books and had collateralized obligations on the books as falling supply and the loan was turning bad. Similarly now a situation came up where in supply was falling below the demand as banks are not able to recover the loans and thus credit risk spread and the default on loans gained pace and it reached to highest amount at 6% in the year 2009 supply was far below the demand and inflation caught up.
Due to rising inflation and default in the loans for bank the supply fell down below and the output came down and there was no demand for the houses which were financed by the banks again this give a kind of situation wherein banks are facing inflationary pressure because of the collateralized debt and no buyers for the mortgage properties.
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