World Bank-Role in Avoiding Economic Crisis World Essay

  • Length: 6 pages
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  • Subject: Economics
  • Type: Essay
  • Paper: #27361898

Excerpt from Essay :

World Bank-Role in Avoiding Economic Crisis

World Bank and Economic Crisis

World Bank: How necessary is World Bank in avoiding an economic crisis?

Increased capital flows and economic crisis

Leveraging the liquidity of developed countries

Global Financial Development Report 2013 (GFDR)

World Bank: How necessary is World Bank in avoiding an economic crisis?

As a result of Bretton Woods's conference, the World Bank (WB) was created in 1944. The most influential role in the establishment of WB was played by the U.S. And United Kingdom. This transnational institution comprises of two main institutions named as International Development Association (IDA) and International Bank for Reconstruction and Development (IBRD). The main objective of this establishment is to provide loans to the under-developed and developing countries. Poverty alleviation and promotion of equitable economic growth are also amongst main objectives of this bank. The outcome of WB loans and funding is aimed to be the promotion and strengthening of international free trade and increment in foreign direct investment (FDI) in beneficiary countries. The bank is actively engaged in multiple projects in different parts of the world aimed at poverty reduction, global partnership and economic initiatives, and environment related economic initiatives. Whilst the role of WB today goes beyond its initially developed scope, the role of this institution in avoiding a looming economic crisis will be the main discussion agenda of this paper.

Increased capital flows and economic crisis

The role of World Bank and International Monetary Fund (IMF) has been commendable in promoting free trade and investment intense projects irrespective of border limitations in different countries. Although, the FDI and other macro-economic indicators have got strengthened, the role of increased capital flows has enhanced the volatility in international money markets and economic systems of developing as well as developed countries. It is observed that whenever economic crisis has gripped developed or developing part of the world, it has been preceded by long-term inadequacy of capital and unsustainable growth. The countries within developed world have far too often experienced hyper-activity in economic progress and this has resulted in 'over-heating' of economy (Lane, 2012). This economic growth has been increasingly fuelled by FDI and speculation within the money markets. Since investors are hyper-sensitive towards any potentially damaging event that results in losses, many economic crisis were the result of panic within the money markets.

The role of World Bank and other lending agencies such as IMF becomes even important in an increasingly integrated world economy. The bank has considerable role in ensuring that beneficiary as well as the donor countries maintain adequate capital reserves. Further, the bank may encourage the domestic institutions of beneficiary countries to claim ownership of initiated programs. These programs should try to avoid neglecting the local and domestic preferences of economy. For instance, the development initiatives of WB have been most successful where institutional framework of economy was already in place and implementation was not jeopardized due to lack of capacity of beneficiary countries. Sub-Sahara African countries were unable to implement the WB led development programs and cuts in social spending and removal of subsidies resulted in even greater inflation and economic crash. The bank's role in maintaining fiscal and debt sustainability is also vital. The bank can promote responsible policy planning and execution as this reduces the chances of an economic crisis like event. It is also observed that the developed countries have utilized paper and plastic money to fuel the unsustainable level of growth within their economies. The vast circulation of debt bonds and other financial instruments that firms and governments use to raise capital are also an important facilitator of economic crisis. Whilst the role of World Bank in avoiding an economic event may be dependent on the cooperation from developed countries, it has a leading role in influencing the policy frameworks of developing countries.

The bank also exerts much influence in policy dialogues and promoting good analytical work to assess the economic growth in countries. Indonesia, Mexico, and Ukraine have benefited from this whereas some Asian and African countries have not been able to take benefit due to their institutional incapacity. Over here, WB's role in partnering with least developed countries (LCDs) is important in providing financial sector expertise. The WB involvement is also necessary in the context that institutional capacity and available resources of the bank allow her to be more sensitive to 'crisis risks'. The early warning signals are usually communicated to the beneficiary countries but then again, same signals to developed countries are either not provided or these developed countries are too strong to be influenced from WB advice. The impact of crisis originating from developed countries, as in case of the U.S. In 2008 and Europe in 2010, is much bigger than an economic crisis originating from developing countries (World Bank. Independent Evaluation Group, 2011). Ibrelji? And Kozari? (2009) mentioned that the role of financial crisis in catalyzing 'an economic crisis' has increased due to money markets. The role of these money markets in making FDI has also increased. Thus, any role of WB and IMF that ignores regulating the money markets may not yield positive results for sustaining economic growth. Most critical role of World Bank is in enduring that governments, through their central banks, maintain adequate level of liquidity that is necessary to withstand the shocks. The cycles of economic boom and busts shall be accounted for while maintaining the liquidity levels.

Leveraging the liquidity of developed countries

The role of multilateral banks such as World Banks is also important in leveraging the excessive level of liquidity maintained by the developed countries. $2,000 billion were committed by Germany, France, Spain, Austria, Portugal, and Great Britain for provision to the WB (Ibrelji? And Kozari?, 2009). These funds were then relayed in form of loans to developing countries. More than five billion Euros were lent to Hungary in order to reduce the shortage of funds in its central bank. The overall amount committed by the donor countries will be directed towards crisis overcoming and crisis mitigation. Thus, role of WB and its allied institutions in maintaining free cash in developing countries has been immense. It is also observed that a 'virtual' economy in form of online and integrated money markets has surfaced along with the real economy. The major threat of crisis like situation emancipates from 'virtual' economy in undermining the progress made in the real economy. To avert such crisis in which the 'virtual' undermines the real; the role of WB is even more. With presence in all continents, the bank is in a better position to respond to emergency and avoiding any economic events. Since most of the events are triggered by 'panic' by investors and general public, the bank can effectively communicate the real situation and avoid any 'panic triggered' crisis (Summers, 2000).

The role of stock markets in presenting an economic outlook of countries has become important in this virtual economy. The role of these stock markets in sending signals towards confidence on economic system is also important. It was observed that as the news of financial crisis reached world markets, the investors in Brazil and Mexico sold everything that was considered risky and the stock market plunged by more than 56% and 40% respectively. Since the manufacturing industries of these countries were highly indebted and the banks depended on foreign sources of finances, this led to the financial shocks being converted into real economic crisis. It is also observed that the Balkan countries were using a restrictive policy in context of obtaining loans and their banking system was conservative and non-integrative. This saved these countries from experiencing the initial shocks of finance markets. Serbia and Croatia remained saved from excessive impact of financial crisis and thus an economic crisis did not ensue after the 2008 financial crisis. The banks of these countries had not obtained significant portions of their loans from foreign banks and thus returning these loans was never an issue for the local banks. The use of complicated financial derivatives also induces the economic crisis in an event of financial crisis. Since the growth and development of economy is based on derivatives, any underlying shock is quickly translated into real economic threat and growth in the countries is halted where derivatives are used for fueling growth, investments, and hedging risks. The role of World Bank in actively reassessing the economic policy decisions of different countries and regions is also vital. Recently, the bank published 'Global Financial Development Report 2013 (GFDR)' in which it was assessed that there were many potential benefits in governments playing a role in regulating the financial markets of their countries (Bretton Woods Project, 2013). There were stated some 'sound economic reasons' for the state to play an active role in managing the financial markets that have an immense and immediate effect on economic system of a country. With an integrated banking system that has real time information being channelized through it, the threat of hyper-sensitivity to the bad news is obvious. Financial sector…

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