Causes and consequences of the financial

Key Takeaways The bursting of an asset bubble, or the rapidly declining prices of an asset class, usually leads to a financial panic, reductions in the quantity of available credit, and the de-leveraging of the financial system. The most highly leveraged investors suffer most. As noted above, financial panics and the de-leveraging that often occur after them can wreak havoc on the real economy by decreasing the volume of loans, insurance contracts, and other beneficial financial products. That, in turn, can cause firms to reduce output and employment.

Causes and consequences of the financial

Synopsis Foreword Financial crises are damaging and contagious, prompting calls for swift policy responses when they happen, and justifying much effort to avoid them. As seen in recent years, crises can result in deep and long-lasting recessions and, in some cases, can trigger sharp current account reversals.

Unsustainable macroeconomic policies, excessive credit booms, large capital inflows, and balance sheet fragilities appear prominently as common patterns before financial crises. However, not all crises are preceded by such events.

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Some crises can be contagious and rapidly spread to other countries with no apparent vulnerabilities. The quest for knowledge on the best predictors of, and the best policy responses to, financial crises is ongoing. Extensive research has been conducted on various aspects of crises, including analyses of centuries-old episodes.

The IMF has been closely involved in the resolution of crises and in mitigating their macroeconomic impact. In addition, the IMF has pursued a comprehensive research agenda over the years to analyze the causes and consequences of financial crises, to develop best measures to prevent crises, and to formulate strategies for coping with their consequences.

Moreover, the IMF has been a major international forum for researchers and policymakers to debate and exchange their views on these issues.

As a result of these collective efforts in academia and policy institutions, much knowledge has been accumulated on the causes, evolution, and resolution of various types of crises. Despite the progress so far, these issues remain topics of intense policy discussions, as ongoing events clearly remind us every day.

Therefore, there is much value in having leading researchers in the field of financial crises provide their cutting-edge perspectives on the topic, combining their contributions with those of economists at the IMF, and disseminating these insights broadly.

Causes and consequences of the financial

This book exactly serves this purpose. Prevention is always better than a cure, so the book includes a detailed analysis of the key factors leading up to financial crises.

Increases in leverage and rapid credit growth are seen time and again. The contribution by Carmen Reinhart and Kenneth Rogoff Chapter 3building on their studies of crises over a very long history, makes this pattern quite evident. The book has valuable lessons on how countries can better monitor their economies and financial systems.

However, rapid changes in financial systems and growing linkages among economies mean that it is still quite difficult to find robust patterns that can help us to predict crises accurately.

Given the developments witnessed during the —09 episodes, the view that only emerging markets are prone to crises is surely wrong. Advanced economies were at the epicenter of the crisis, whereas many emerging markets proved relatively resilient.

In addition to the chapters by these eminent scholars, a number of contributions from researchers at the IMF are presented in the book. These chapters focus on the causes and consequences of financial crises, and on the best policies for their resolution.

Recent work on credit booms and banking crises conducted by IMF researchers confirms academic research on the critical role of rapid credit expansion before crises. This work has found that one in three boom episodes ends in a crisis. Although it is difficult to differentiate a good credit boom from a bad one beforehand, this research shows that bad booms tend to be longer.

Specifically, roughly half of the booms lasting longer than six years ended in a crisis. Research conducted at the IMF also documents that cross-border financial linkages have intensified and become more complex. Increased linkages promote risk diversification by reducing exposure to local shocks, but global financial networks also transmit shocks and can make the sudden elevation of systemic risk more likely.

As research advances, we hope to further improve early detection of vulnerabilities. As we learn more about incentives and factors that lead to financial fragility, we will be able to design better policies, including macroprudential ones, and improve the institutional infrastructure and strengthen supervision, thereby reducing the incidence of crises.

Having said this, I am realistic enough to realize that there is a long road ahead in having the knowledge and tools, combined with the necessary political will, to prevent all financial crises.Understanding Financial Crises: Causes, Consequences, and Policy Responses Stijn Claessens, M.

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Financial Crises: Causes, Consequences and Policy Responses: