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Finance Essay
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Hence, if growth is mediocre and the country is running a big CA deficit, it should be a
cause of worry because it means that the constrained (i.e. the long-run) growth of the country
may be low. This is the case when the income elasticity of imports is greater than that of
exports. Relatively low domestic inflation and/or continuous devaluations will relax the
constraint but the deflationary costs of the former and the inflationary implications of
the latter limit their effectiveness. Protectionism cannot help at all since its effects
are once and for all, except if it accelerates the development of domestic industry. In a
Keynesian world, the low constrained growth rate may even lead to continually rising
unemployment (except if some sort of a NAIRU relationship exists). A further implication
of these theories is that the period for which a country can maintain a CA deficit is lower
than in a static model since as time goes by, ceteris paribus the BOP deficit will increase
as domestic and world incomes rise.
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Eventually, some insiders decide to take their profits and sell out and the increase in
prices begins to moderate. A period of "distress" may then occur until speculators realise
that the market can only go downwards. The crisis may be precipitated by some specific signal
such as a bank or firm failure or a revelation of a swindle; the later are quite frequent in
such circumstances as people try to escape the imminent collapse. The rush out of the real or
long term assets ("revulsion" in Minsky's terms) lowers the prices of these real assets which
were the object of the speculation and may develop into a panic. The panic continues until
either the price falls so low that people are tempted to keep their illiquid assets or a lender
of last resort intervenes and/or manages to convince the market that money will be made
available in sufficient volume to meet the demand for cash.
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TA weakness of the approach is that it assumes that what has been done by the majority is the
most appropriate practice. For example the theorists (Ijiri, Patton etc) in favour of the
inductive approach believe that the historical cost accounting which is based on past events
is the best accounting convention that should be used in the valuation of assets and liabilities.
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