Lecture 6 Flashcards
Economic crisis
When there is a slowdown in the economy, and/or a sudden devaluation of assets – i.e. a lot of people lose a lot of value. Often this is when GDP growth slows down to zero (recession) or below zero (depression). This is characterized by high unemployment, and often other types of crisis as well
Financial crisis
Type of economic crisis in which certain financial assets lose a good deal of their value, and/or the financial system (banks) run into sudden problems with debts and/or liquidity
Currency crisis
Where the currency suddenly devalues. This is a subspecies of economic crisis and financial crisis; it often starts because of a chronic Balance of Payments problem. But it can be triggered by other problems with fundamentals, and/or investors suddenly leaving a currency.
Hyperinflation
A rapid increase in the overall price level of a country, typically defined to be 40 percent or higher on an annual basis
Balance of payments and currency crisis
- When currency depreciates because investors flee, realizing that exports won’t cover desired imports
Asset price deflation
- Aka stock market crash – financial assets suddenly lower in value
- Usually leads to credit crunch
- Will put downward pressure on currency as foreign capital leave
Banking crisis
- The banking system is hit by panic, and people demand funds
- This can lead to credit crunch
- And decrease in value of currency as foreign investors leav
External debt crisis
Sovereign default on debt obligations to foreign creditors or substantional restrucuring of this debt
Domestic debt crisis
- Central bank or central government (treasury) refuses to pay banks back debt, or restructures it
- Both external and domestic debt crises put downward pressure on currency
Contagion
Financial contagion is the spread of an economic crisis from one market or region to another and occurs at a domestic or international level.
Three contributing factors to contagion are:
* Sudden reversals of capital inflows
* Surprise announcements to financial markets
* Highly leveraged financial institutions
* This means, they have a high level of debt relative to asset
System risk
If the global financial system becomes contaminated, this is called systemic risk
First generation currency crisis
Speculative Attack leads investors to leave the currency
Second generation currency crisis
Investors believe that the government will not keep its
resolve
Third generation currecy crisis
Argues that banking sectors interact with currency crises; and of course this makes sense
Old fashioned currency crisis
- This is typified by what happened to Mexico in the 1990s
- Mexico gained large amounts of foreign capital because of NAFTA, which inflated the value of its currency and led the government to issue a lot of debt
- When investors got scared, they withdrew currency
- So it was a speculative attack, but arguably precipitated by the fact that Mexico could not pay for all the imports it started buying with inflows of foreign currency
Optimum currency area
- An optimum currency area is characterized by the following criteria:
- Well-integrated factor markets
- Well-integrated fiscal systems
- Economic disturbances that affect each country/region in a symmetrical manner
What happens if you have high unemployment in a monetary union
- You can address unemployment in one of our ways:
1) Decline in wages, leading to increase in quantity demanded of labour
2) Labour mobility out of area of unemployment
3) Expansionary monetary policy (at the EU level)
4) Expansionary fiscal policies (at the member country level)
IMF
Helps to ease balance-of-payments problems, supervise bailouts
(Iceland, Ireland
ESM
(European Stability Mechanism): like an IMF for Europe (from
Sept 2012)
ECB
(European Central Bank): buys some bonds, to keep the market from collapsing
NCBs
National Central Banks, which issue sovereign debt and execute fiscal policy for member countrie
