Financial Crisis Flashcards
Types of financial crisis
- currency crisis - when a fixed XR collapses or s currency goes into a free fall
- BoP or external debt crisis
- sovereign debt crisis
- banking crisis
- corporate debt crisis
- household debt crisis
- broad financial crisis (all the above)
What is a financial crisis
Disturbance to financial markets - often falling asset prices disrupting the market’s capacity to allocate capital
What is an insolvency crisis
When the debt for someone / bank / business is to high relative to income so that it cannot pay back its debt + interest
What may insolvency crisis require
Some form of debt restructuring / debt relief to lower default risk
What is illiquidity crisis
When an agent is solvent and it’s debt is not unsustainable but it has large amounts of this debt coming into maturity and is not able to roll it over
What can illiquidity lead to
Insolvency as illiquidity can trigger default
Who may step in during a liquidity crisis
International institutions to provide emergency funds as a ‘lender of last resort’
Root causes of the Great Recession 2008-2009
US housing and mortgage bust
Liquidity and credit crunch spread to all credit and financial markets
Etc.
Economic and social risks from financial instability
Bailout costs Unpaid debts Lost quiet Lost jobs Increased gov deficit
How does a financial crisis hit business investment
- higher costs of credit
- falling asset prices weaken bank balance sheets
- fall in lending
- fall in economic consequence
- fall in share prices
How might a financial crisis create a higher cost of credit
Commercial banks become more risk adverse and may raise interest rates on higher risk loans
How might a financial crisis weaken bank balance sheets
Falling asset prices weaken bank balance sheets and mean they have less money to lend out. Banks restrict credit to rebuild capital.
How might a financial crisis cause a fall in business confidence
Fall in asset prices causes a fall in consumer spending / AD and economic confidence - businesses likely to invest when spare capacity is growing
Credit and the upswing of asset price cycles
Asset prices e.g. houses rise people have future expeditions of it increasing further = increase borrower demand for credit when commercial banks are willing to lend due to expectation of higher profits
The downswing of asset price cycles
When asset prices fall lenders tighten on lending.
