4 Describe how a sudden stop leads to a financial crisis 4 5

4. Describe how a sudden stop leads to a financial crisis. 4 5. What does a current account deficit do that is positive for a nation? 6. It is unclear whether the free flow of capital is beneficial to all countries. Explain the benefits and costs of allowing capital to move freely.

Solution

4.

Sudden stops refers to a scenario, when the net capital inflows in the economy, slows down drastically. It causes the asset prices to come down and correction in the price of assets takes place. It negatively affects the consumption spending and aggregate demand decreases to the left. It causes the aggregate supply to decrease and unemployment increases in the economy that further leads to the decrease in aggregate demand.
Decreases in prices of the assets, also lead to decrease in value of the assets at different book of accounts. Besides, the decrease in asset prices, causes the individuals to make default upon their interest payment commitment and financial institutions suffer from default and bad loans. It creates financial and economic crisis in the economy.

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