C. 9 Financial Crises Flashcards
Financial frictions
Asymmetric information problems which act as a barrier to efficient allocation of capital
Financial crisis
When information flow in financial markets experience a particularly large disruption, which the result that financial frictions increase sharply and financial markets stop functioning. Then, the economy collapses
Financial liberization
The elimination of restrictions on financial markets and institutions
Credit boom
When financial institutions go on a lending spree
Stages of financial cresis
1) Initial Phase
2)
3) (sometimes)
Deleveraging
When financial institutions with reducing capital cut back on their lending to borrower-spenders
Stages of financial cresis
1) Initial Phase
2) Banking Crisis
3) (sometimes) Debt Deflation
Consequences of the initial phase
- Adverse Selection
- Moral hazard problems worsen
- Lending contracts
Loans become scarce, so borrower-spenders aren’t able to fund productive investments and decrease spending which causes the economy to contract
Fundamental economic value
Value based on realistic expectatons of the assets’ future income streams
Initial phase
Increase in uncertainty, asset-price decline, and deterioration in FI’s balance sheets lead to:
- Adverse Selection
- Moral hazard problems worsen
- Lending contracts
Loans become scarce, so borrower-spenders aren’t able to fund productive investments and decrease spending which causes the economy to contract
Banking Crisis
Economic activity declines
- > Banking crisis
- > Adverse selection, moral hazard problems worsen, and lending contracts
- > Economic activity declines
Debt Deflation
Unanticipated decline in price level
- > Adverse selection, moral hazard problems worsen, and lending contracts
- > Economic activity declines
Insolvency
Net worth becomes negative
Fire sales
Banks sell of assets quickly to raise the necessary funds
Bank panic
Multiple banks fail simultaneously
