1 - Overview

Question 1

What is banking crises?

Answer 1

It is when banks have severe problems with insolvency or illiquidity. Ex. banking panic and stock market crashes.

Question 2

What is currency crises?

Answer 2

It is a market based attack on exchange value of a currency, i.e. a sudden and steep decline in the value of a nation’s currency

Question 3

Twin crises?

Answer 3

When both banking and currency crises occur within a short period of time.

Question 4

What is the meaning of “contagion” in the financial crisis area?

Answer 4

It is the rapid transmission of a financial crisis between markets/countries without a cause in underlying (real) factors.

Question 5

Systematic risk in the area of financial crises?

Answer 5

When there is an instability in the banking system, arising from interconnections between different banks –> the danger of bank default without being insolvent as a result of fall in liquidity. Whole financial system freezes.

Question 6

What is a bubble?

Answer 6

When the market price rises above the fundamental value due to overly optimistic expectations of the future value.

Question 7

Which continent have had most crises going on in the past?

Answer 7

Asia. Very unstable.

Question 8

Average duration of default?

Answer 8

Around 2-3 years. But there are som outliers, ex the Russian default that lasted for about 70 years.

Question 9

Why is it a problem with long defaults?

Answer 9

You as a country cannot take on more loans/debt –> hard to use the investments as a smoothening function..

Question 10

Describe sovereign debt:

Answer 10

Either it is internal - that the country owes its own citizens, or it is external - debt to foreign areas. Always easier to pay back in own currency because you can tax your people.

Question 11

Relationship between commodity prices and defaults?

Answer 11

When commodity prices are low, defaults tend to happen more often.

Question 12

Relationship between capital flows (current account balance) and defaults?

Answer 12

When capital flows collapse and decrease, there seem to be more defaults. Hard to finance the debts.

Question 13

Relationship between capital mobility and banking crisis?

Answer 13

Positive. Seems to be the case that when capital mobility is high, there are also more crises.

Question 14

Is inflation correlating with defaults? Any link to fiat money?

Answer 14

Yes, in periods when a lot of countries have had high inflation rates, there have also been more defaults. And high inflation became more common as we moved away from currencies containing the actual metal value –> moving toward fiat money through currency debasement.

Question 15

Are crises becoming more frequent?

Answer 15

Yes. According to the first paper by Bordo et al. the crisis frequency in the latest period of their sample is 12.2%, which exceeds even the most unstable inter-war period.

Question 16

Which type of crisis has become most common, driving the frequency up the most? Related to globalization? demomcratization?

Answer 16

Currency crises and twin crises. –> cannot be only due to globalization as this started already in the beginning of 1900s and at this time currency crises were rare. Must be a combination of capital mobility and democratizaiton.

Question 17

Where does the majority of crises occur?

Answer 17

In emerging countries.

Question 18

Have much changed over time when it comes to duration and severity of crises?

Answer 18

No.

Question 19

Are banking crises more costly when open-ended liquidity support is provided?

Answer 19

Yes, because when CBs help the banks, it is a bad help. They simply facilitate the continuing flow of financing to loss-making borrowers.

Question 20

Average cost of crises?

Answer 20

5-10% of GDP.

Question 21

Why did we see so large current account imbalances in the 1800s compared to today?
Hint: Arg, Aus and Can had very high inflows of capital (current account deficit).

Answer 21

Because we had large return differentials across countries. For ex, Aus, Can, Arg, had very high land/labor ratio and hence higher returns on capital - so even if we transfer capital faster today, we had more capital chasing the returns back in the days. Today we don’t have these large differentials.

Question 22

How can covered interest parity be a good measure of financial globalization?

Answer 22

Because there should be no differentials, no arbitrage, if the financial markets are completely free. But what we see in later years is that the differentials are unstable, larger deviations than before 1910. BUT limitation with the measure is that all countries don’t have forward rates, which we must have to compute the arbitrage.

Question 23

Why don’t we just regulate the financial market so much so that no crises can occur?

Answer 23

Because financial crises is the downside of positive growth. The optimal number of crises is not 0, because it it a side effect of growth and we want growth. Ex Thai - financial development and grew a lot, then a hard recession but on average higher growth than India. We must accept crises if we want to grow.

Question 24

What is the problem with talking about bubbles? Hint: fundamental value

Answer 24

Because if a bubble is a situation where the price of an asset deviates from its fundamental value, we need to know the fundamental value, which we will never know about….

Question 25

Two strategies for thinking about and handle bubbles empirically?

Answer 25

1. We don’t know the fundamental, so we make assumptions and push the valuation of an asset to its extreme and the residual is the bubble.
2. We look at behavioral price patterns to try to understand what people think and do.