Financial market stability and Marker ConfidenceIntroduction during the great depression, that the fall in the use of money was at least to some extent unrelated to the pattern of money creation, and instead also the consequence of a drastic deterioration in the acceptance of bank money as payment medium.
Bank money, being a credit instrument, bears a credit risk which normally is negligible but in rare circumstances it sharply increases to the point of triggering a generalized confidence crisis, in its use as a payment instrument, with significant macroeconimic consequences. Macro global problems is considered as the true background to today’s financial crisis. It is undeniable that the low interest rates and excess liquidity that have prevailed around the world since the collapse of the IT bubble are behind the crisis. In fact, when there are significant differences in the degree of development of individual countries’ financial markets, a situation like the global imbalances that appear on the surface to be a disequilibrium can in fact be one kind of equilibrium itself.
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One of the reason for the collapse of ‘credit bubble’ which as a result deepen the financial crisis is collapse of confidence. on the other hands, one of the distinguishing features of the current financial crisis is the liquidity crisis caused by the materialization of counterparty risk. The global economy today has fallen far beneath its potential and is seemingly unable to pull itself up. The root cause of this is the erosion of confidence in the market.
When confidence is eroded, market participants become extremely fearful that they might be confronting a completely unpredictable and uncertain world. In this case, for market participants who want to behave rationally, the most natural course is to assume the most pessimistic scenario and make the best of it. The melt down that took place in 2007 represents the major market failures in a wide scale. In credit market we have both lenders and borrowers and confidence plays important roles in this transactions. Lenders require two elements both money itself and confidence to lend to someone.The credit and liquidity crunch of 2008 has demonstrated that a loss of confidence among market participants can lead to a drying up of liquidity and freezing up of credit markets, which then severely disrupts and threatens the overall financial system.
Instability in the financial sector may bring about significant economic costs as the overall economy requires a stable financial sector for its own functioning, with devastating consequences for the overall economy.Maintaining market confidence is fundamental for the functioning of the financial system during good times, but becomes crucial during a crisis or market turmoil.During times of crisis and market panic, when confidence in the market is shaken or has disappeared, it has to be restored in order to ensure continuous trading and liquid markets.Moreover, finaincial stability requires (1) that the key institutions in the financial system are stable, in that there is a high degree of confidence that they can continue to meet their contractual obligations without interruption or outside assistance. TrustTrust is the very crucial elements in the effective and proper economic functioning. not only inexchanges between particular agents, but in terms of a wider socio-economic system. Trust instrumentally promotes economic efficiency on the assumption that on the assumption that others will behave according tocommon norms of economic conduct.
It might be possible to transact without this underpinning principle of trust but this transaction cannot be effective where the risk and associated costs of doing so is much higher than where individuals have a reasonable expectation that others will deal plainly. The reduction of economic uncertainty, the”oiling” of exchange relations, the management of risk, can be seen to foster economic efficiency at a macroeconomic level as well as within any given exchange. Trust leads a double life as both a social value and an economic resource; as such, it is a critical concept for linking social arrangements with economic outcomes.Distinguishing between Trust and ConfidenceDifferent researches reveals that there are wider economic discourses concerning the role of trust in economic life. Notable here is the recent effort of George Akerlof and Robert Shiller to revive the Keynesian notion of “animal spirits” for the study of global capitalism. For Akerlof and Shiller animal spirits refer to the non-rational dimensions of economic behavior. Akerlof and Shiller address five, more or less distinct, animal spirits: confidence; concern for fairness; corruption or other anti-social behavior; money illusion; and the role of “stories” in shaping economic behavior. Each of these has an explanatory role in respect of the current crisis, but my particular focus here is on confidence.
The general underlying principles in this assumption is economic relations are only possible on the basis of shared expectations regarding the conduct of economic exchange. Confidence is said to be established when the people are about to make the rational decisions make rational predictions. Some authors use the term Trust and Confidence interchangeably reducing that the distinction of the two term only to technical matter. Others however argue that both are different. For example their role in causing the economic cries may be different.
Forinstnace, the seizing up of interbank lending is not so much a failure of trust but a crisis of confidence. On the other hands, If banks lack solid information regarding the value of other banks’ assets and liabilities, and therefore their credit risk, they lack a basis on which to make rationally weighed decisions about lending: in the absence of reliable information, they cannot have confidence that the borrower is in a position to repay the loan. If, in contrast, banks suspect that their partners in these exchanges are, or might be, dissimulating or lying about their capital reserves or asset values, then this represents a failure of trust.similarly, Similarly, if I decide to invest in a company’s stocks on the basis of their performance over time, their current stock position, and their market strategy, then I am acting on the basis of confidence. If I decide to put capital into a start-up based on my analysis of the market, and the firm’s business and investment plan, I am acting (if more riskily) on the basis of confidence. But if I put capital into a start-up because I met the budding entrepreneur at a friend’s party and liked him, then I am really riding on trust.Still, both are distinctly different notably in the way they are created and the way they are destroyed.
Trust is social and relational while confidence is instrumental and calculative. Trust is willingness , in the expectation of beneficial outcomes, to make oneself vulnerable to another based on a judgments of similarity of intention or values. Confidence is the belief, based on experience or evidence ( E.g. past performance) that certain future events will occur as expected. The basis for the confidence is past performance or institutions, procedures designed to constraint future performances.
In this past performance, controlling institutions procedures can be measured in a variety of ways, by indicators of evidence, regulations, rules/procedures, contracts, record keepings/accountings, ability, experience, competence and standards. Therefore, confidence is the key to market success which business relying on regulations, rules/procedures, record keeping and accounting. Of course there is a large shaded area between these two categories but, in short, relations of confidence tend towards the side of objective information, external regulations over conduct, contractual agreements, rational and informed decisions; while relations of trust tend towards subjective perceptions, moral sanctions, gentlemen’s agreements, non-rational choices.Trust, confidence and economic regulationExpectations are a major factor in the financial system. They cause fluctuations especially in the short run, in a situation of uncertainty. In an open economy with no government intervention, uncertainty and expectation may cause significant changes in the financial system. In a dilemma where there is an expected rise or fall in the value of money, economic agents change their demand or supply of financial assets as perceived to be economic animals. If the value of money is expected to decrease, economic agents who wish to avert losses, increase prices.
This may spark a chain reaction which can change money market factors like exchange rates which can begin the inflation and may lead to short run shortages in an economy.in the process of building confidence through information, regulation, and contract, makes the people to have build the ‘trust’ in the economic transaction. The reasons for subjective evaluations and their coagulation in to conventional market value is uncertainty. where the market speculator cannot know the future value of his investment, he is going to make the judgment with a greater degree of ‘confidence’ according to the weight of evidence available to him.
This confidence veers between optimism and pessimism. Expectation in their return are determinant more by recent experience than the more distant past. Therefore, when there is a boom, there is over optimism and when there is a recession, the expectation is over pessimistic.Subjective evaluation here is the expectation of yield determined based on the current supply price of the capital asset. Risk premium(A risk premium is the return in excess of the risk-free rate of return an investment is expected to yield; an asset’s risk premium is a form of compensation) is uncertainty about the prospective yield on investment.
In Keynes’s theory (General theory) of speculative demand for money confidence has the objective of securing profit from knowing better than the markets what the future will bring forth. He recommended the adjustment an interest rate to balance the speculation. For instance, he suggested the remedy for the boom is not the higher rate of interest but a lower rate of interest.