Financial crises – theory

Question 1

Financial crisis

Answer 1

– a strong disturbance in the financial system causing a decline in production or a deepening of an already existing decline

Question 2

Stock market crashes

Answer 2

1) Rare but very destructive
2) The source is speculative bubbles
3) Stock market crashes can be explained with behavioral finance
4) Small investors follow the trend without in-depth analysis
5) Large investors can predict the bursting of the bubble but are reluctant to sell off assets
6) The bursting of the bubble worsens the situation of investors who financed their assets with loans (e.g. the stock market crash in Japan in the 90s)

Question 3

Consequences of index collapse

Answer 3

1) Inability to repay loans

2) Collapse of domestic demand

Question 4

Banking crises

Answer 4

1) Propensity to lend during a bull market and reluctance to grant during a bear market – a pro-cyclicality that highlights the business cycle
2) During a bear market, companies take loans to maintain liquidity, apply for loans that they cannot repay
3) Banks demand a higher risk premium > increase in the cost of credit
4) As a result, only desperate companies on the brink of bankruptcy apply for loans
5) Banks grant such loans that become “toxic assets”

Question 5

Currency crises

Answer 5

1) A currency crisis occurs when market participants massively lose confidence in a currency and begin to sell it en masse and the central bank is unable to resist this.
2) The result – a sudden drop in the value of the currency
3) Crises of three generations
• First generation – Krugman
• Second generation – Obstfeld
• Third generation – eclectic model

Question 6

First Generation Crises – Krugman’s Model

Answer 6

1) The reason for the crisis is the bad economic policy of the state
2) Inability to reconcile economic policy with the exchange rate target
3) Expansionary state policy - > budget deficit financed by the central bank - > inflation - > inability to maintain the exchange rate
4) Budget deficit -> increase in demand and imports and inflation -> trade balance deficit -> decline in reserves -> devaluation -> speculative attack -> crisis
5) In the 80s in South America

Question 7

Second generation crises – The Obtfela model

Answer 7

1) The reason for the crisis – speculative attacks
2) This crisis affects countries with good economic policies and large foreign exchange reserves
3) The speculator at the moment of attack chooses the time when the monetary authorities will stop defending the exchange rate
4) According to the model, two situations can occur
5) ERM crisis in the early 90s
6) Restructuring of the German economy -> budget deficit -> inflationary pressure -> restrictive monetary policy -> high exchange rate of the German mark
7) Raising interest rates in EU countries in addition to the UK -> speculative attack on the British pound -> wave of devaluation

Question 8

4) According to the Obtfela model, two situations can occur

Answer 8

• No expectation of devaluation

* Expectation of devaluation – the state adapts to market expectations

Question 9

The crisis of the third generation – an eclectic model

Answer 9

1) Good macroeconomic situation of the country, crisis caused by excessive risks taken by companies and banks (microeconomic factors)
2) Moral hazard of lack of financial supervision – > taking out risky loans
3) Low productivity growth – investors are starting to worry
4) Excessive debt – sheep’s rushes of investors in withdrawing from investments
5) Negative ratings of credit rating agencies – a self-fulfilling prophecy
6) Domino effect – the crisis is expected to occur in similar economies

Question 10

Twin crises

Answer 10

currency and banking crisis

Question 11

Southeast Asia in the 90s –

Answer 11

the crisis of the 3rd generation