Financial Accelerator Mechanism
The link between the real economy and financial markets stems from firms’ need for external finance to engage in investment opportunities. Firms’ ability to borrow depends essentially on the market value of their net worth. The reason for this is the familiar story of asymmetric information between lenders and borrowers. Lenders are likely to have little information about the reliability of any given borrower. As such, they usually require borrowers to set forth their ability to repay, often in the form of collateralized assets. It follows that a fall in asset prices deteriorates the balance sheets of the firms and their net worth. The resulting deterioration of their ability to borrow has a negative impact on their investment. Decreased economic activity further cuts the asset prices down, which leads to a feedback cycle of falling asset prices, deteriorating balance sheets, tightening financing conditions and declining economic activity. This vicious cycle is called a financial accelerator. It is a financial feedback loop or a loan/credit cycle, which, starting from a small change in financial markets, is, in principle, able to produce a large change in economic conditions. Read more: http://www.investopedia.com/terms/f/financial-accelerator.asp#ixzz2KdGqitbZ
Read more about this topic: Financial Accelerator
Famous quotes containing the words financial and/or mechanism:
“A theory of the middle class: that it is not to be determined by its financial situation but rather by its relation to government. That is, one could shade down from an actual ruling or governing class to a class hopelessly out of relation to government, thinking of gov’t as beyond its control, of itself as wholly controlled by gov’t. Somewhere in between and in gradations is the group that has the sense that gov’t exists for it, and shapes its consciousness accordingly.”
—Lionel Trilling (1905–1975)
“The two elements the traveler first captures in the big city are extrahuman architecture and furious rhythm. Geometry and anguish. At first glance, the rhythm may be confused with gaiety, but when you look more closely at the mechanism of social life and the painful slavery of both men and machines, you see that it is nothing but a kind of typical, empty anguish that makes even crime and gangs forgivable means of escape.”
—Federico García Lorca (1898–1936)