Implications In Business Labor Dating

Q1

Adverse selection according to Bariggozzi and Raggi (2010), occurs when one party in a negotiation has more relevant information, skills or any advantage over the other party. Being in the disadvantageous position often informs bad selections for instance in business agreeing to do more business with lesser profit or in markets that are too risky. Within the labor market adverse selection may occur where an employee has less informed and less skilled laborers that are cheap and manageable for them as compared to the large pool of laborers available in the market with highly refined skills and abilities for the job, but quite expensive for the employer to comfortably pay. According to Greenwald (1986), viewing adverse selection in a three way interaction among employers, their current workers and the universe of alternative employers may seriously impair a workers freedom to change jobs as their reputation is and therefore bargaining power for future jobs is lowered when they change jobs.

In the labor market different workers differ in their productivity levels at any point of the production or work process, bringing in second source of workers with intrinsic motivation for the job is likely to boost the current workers moral and enable their increased productivity. Bariggozzi and Raggi (2010), further outline that when workers are motivated, inefficiencies related to adverse selection decrease and the competitive equilibrium is characterized by a higher wage. Adverse selection can also occur in dating where one potential partner has better qualifying features than their alternatives however they offer one important quality that leads to their biased choice.

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Q2

Compensating balance refers to a minimum bank account balance that a borrower agrees to maintain with a lender for the purposes of providing indirect compensation for loans extended to the borrower. According to Shapiro and Baxter (1964) it is especially common among corporate who lend money with banks to fund huge developments and pay up later with profits ripped from the investment made. it increases the cost of capital to the borrower because they eventually pay interest to more money than they are allowed to use and in this way the moral hazard problem in bank lending can be resolved. For example an investor may borrow $10 Million for a project for which he/she will be fully paying annual interest on. However due to compensating balances and given it set at $1 Million the investor can only withdraw for use $9 Million of the $10 Million borrowed.

The amount of cash remaining in the account is the compensating balance which will annually earn interest and indirectly compensate the loan granted to the investor. Bragg (2018) further highlights that compensating balance serve to minimize the cost of lending by the lender since the lender (in this case the bank) can invest the cash located in the compensating bank account and keep some or all of the proceeds and profits as an indirect payment for the loan offered to the borrower. For example a bank Lends $20 Million to an investor $18 Million of which they can withdraw for use, the bank can then invest the remaining $2 Million in compensating balance to other ventures and generate cash to cover the $20 Million lent out to the borrower.

Q3

According to Amadeo (2018), the Glass-Stegall Act enacted in 1933 separated investment banking from retail banking which ensured that the rate of interest for the two purpose banking were different and thus moral banking hazard was controlled. This meant that that retail banks were prohibited from using retail depositors fund for large, costly and risky investments such as corporate and commercial investments. Investors of risky investment could only bank with, and borrow for use, funds from investment bankers who had high interest rates to control the rate of lending and thereby minimize moral hazard. However the repealing of the legislation which separated commercial banking, insurance and investment banking, opened new doors for creation of two big mergers and acquisitions which borrow huge amounts for investment. It also allowed cross subsidization of risks between commercial investors and retailers which made borrowing retailers’ funds almost impossible to control or manage.

Most corporate borrowers used the stock market as collateral for their loans from big banks sometimes describes as ‘too big to fail’ giving out hefty loans which could not be instantly repaid to enable the bank have adequate real cash at any particular time. As a result when the stock market collapsed, the banks were left with big loans to repay within short periods of time and subsequently collapsed leading to the 2008 financial crisis. The lack of separation of the investment funds and retailers’ cash as well as the need of the banks to both retain money for bankers as well as invest it led to the repealing of the bill which left bare grounds for operations of banks subsequently resulting to the 2008 financial crisis.

Q4

A policy that the federal government could use to minimize the rise of lending in 2007 would have included reinstating the Glass-Steagall policy and enacting the Volcker rule amendment therein which would effectively put restrictions on the banks ability to use depositors funds for risky investment (Elliot, 2011). While banks would not be regulated in their growth and which sector to operate in, the utilization of their funds will be regulated by some prime amendments within the bill this ensures minimized lending as cash to be lent out is also minimized. Other monetary policies such as increasing interest rates for risky projects and borrowing of depositors funds could further greatly minimize the rate of lending.

Both the UK and the US did not apply the policies at the time due to the high rate of development that both countries experienced during this period. Banks being limited to either investment or retailer banking slowed down their operations and ability to grow and be able to finance big development projects the countries were engaging at the time (Arnold,2018). Banks needed to be able to keep their bankers money as well as have the freedom to lend the stagnant money out and invest in business and development ventures to further boost and maintain the rate of the countries development.

Greenspan put highlights a belief by investors especially in the stock market that the commercial banks would intervene when the financial market experienced some difficulties. Kuepper (2018) highlights for instance that investors are given a put by central banks on the price floor of their investment such that a bank can guarantee an investor that their shares in the broad market index will not drop below 20%, and incase it did then the central bank will intervene with low interest rates to boost equity valuations. In doing this the country might experience a financial problem known as inflation. Inflation is a problem arising due to the economy flooding with cheap cash which makes the prices of products to go up. Due to the low interest rates borrowing rates increase leading to increased debts and a lot of money in the economy which eventually leads to the collapse of some commercial banks (Duy, 2018).

Q5

Macro prudential regulation is the approach to financial regulation that aims to mitigate risk to the financial system as a whole, the focus of the central bank over the last two decades has been to reduce the risk and the macroeconomic costs of financial instability. This through the control of capital as well as loans to the outcome value ratio, monetary tools such as interest rates, fiscal policies such as taxes, exchange rate policies, capital control as well as competition policies

The instrument used includes strategies developed specifically to assist with the mitigation of systematic tasks. Most commercial banks currently use monetary instruments such as interest rates to control the rate of borrowing by investors as well as maintain a substantial amount of reserve deposits. According to Worldbank.Org (2018) some other instruments include Countercyclical Capital Buffers, ceilings on credit or credit growth, caps on foreign currency lending, reserve requirements, restrictions on profit distribution as well as dynamic provisioning. An additional policy in the macro prudential framework to ensure its effectively and efficiency include adjusting the macro prudential instruments at different phases of the cycle to smoothen out cyclicality.

Macro prudential regulation is quite effective for banking systems especially commercial banks in being able to regulate actions and transactions using the various relegated instruments including single and multiple, targeted and broad based, fixed and time varying as well as rules based and discrete instruments, however the lack of adjustment of the instruments in different phases of the cycle limits its efficiency and as such adjustable instruments should be developed for a more efficient macro prudential regulation.

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References

  • Amadeo K. (2018). Glass-Steagull Act of 1933, Its Purpose and Repeal. Available at
  • Arnold G. (2018). The Glass-Steagull Act: Purpose and Repeal. Available at
  • Barigozzi F. and Raggi D. (2010). Adverse Selection in a labor market with motivated workers. Available
  • Bragg S. (2017). Compenseting Balance. Available at (Accessed October 12, 2018)
  • Duy T. (2018). Powells Fed isn’t about to end the Greenspan Put. Available at
  • Elliot L. (2011). Global Financial Crisis: five key stages. Available at(Accessed: October 12, 2018)
  • Greenwald B. C. (1986). Adverse Selection in the Labor Market. The Review of Economic Studies. 53(3) pp. 325-347 doi:
  • Khon D. L. (2009). Policies to bring us out of the financial crisis and recession. Available at
  • Kuepper J. (2018). Greenspan and Bernanke Put and other Central Bank tools. Available at
  • Shapiro H. T. and Baxter N. D. (1964). Compensating Balance requirements: The theory and its implications. Southern economic journal. 30(3), pp 261-267. DOI: 10.2307/1055935

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