It is widely agreed that the Global Crisis qualifies as a period of ‘systemic’ financial stress. However, identifying and classifying other similar periods is challenging. This column presents a new framework for a transparent and objective identification of systemic financial stress episodes, beyond the expert-selected stress events available so far. The approach is applied to 27 EU countries to successfully identify episodes of financial stress.
Thibaut Duprey, Benjamin Klaus, Tuomas Peltonen, 14 January 2016
Manuel Funke, Moritz Schularick, Christoph Trebesch, 21 November 2015
Recent events in Europe provide ample evidence that the political aftershocks of financial crises can be severe. This column uses a new dataset that covers elections and crises in 20 advanced economies going back to 1870 to systematically study the political aftermath of financial crises. Far-right parties are the biggest beneficiaries of financial crises, while the fractionalisation of parliaments complicates post-crisis governance. These effects are not observed following normal recessions or severe non-financial macroeconomic shocks.
Paul De Grauwe, 07 September 2015
Economists were early critics of the design of the Eurozone, though many of their warnings went unheeded. This column discusses some fundamental design flaws, and how they have contributed to recent crises. National booms and busts lead to large external imbalances, and without individual lenders of last resort – national central banks – these cycles lead some members to experience liquidity crises that degenerated into solvency crises. One credible solution to these design failures is the formation of a political union, however member states are unlikely to find this appealing.
Òscar Jordà, Moritz Schularick, Alan Taylor, 01 September 2015
The risk that asset price bubbles pose for financial stability is still not clear. Drawing on 140 years of data, this column argues that leverage is the critical determinant of crisis damage. When fuelled by credit booms, asset price bubbles are associated with high financial crisis risk; upon collapse, they coincide with weaker growth and slower recoveries. Highly leveraged housing bubbles are the worst case of all.
Xavier Freixas, Luc Laeven, José-Luis Peydró, 05 August 2015
There has been much talk about using macroprudential policy to manage systemic risk and reduce negative spillovers, but there is little agreement on how it could be operationalised. This column highlights the findings of a new book on the topic and offers a framework for operationalising macroprudential policy. Macroprudential measures, together with higher capital requirements, could be used to tame the build-up of leverage and credit booms in order to prevent financial crises.
Francesco Bianchi, 22 April 2015
During the Great Recession, the possibility that the US might enter a second Great Depression was a real concern. This column argues that until early 2009, financial markets behaved in a manner consistent with the early years of the Great Depression. The large stock-market fall saw growth stocks outperforming value stocks. This pattern ended March 2009, arguably in light of robust policy interventions. These dynamics suggest that poor performance of growth stocks during regular times may be compensated by superior performance in crises.
Martijn Boermans, Sinziana Petrescu, Razvan Vlahu, 17 November 2014
Contingent convertible capital instruments – also known as CoCos – have grown in popularity since the financial crisis. This column suggests that the search for yield and the tightening of capital requirements have resulted in a new wave of CoCo issuances. While many of their features and risks remain unclear, CoCos may act as a buffer that makes banks more resilient in times of crisis.
Bruno Biais, Jean-Charles Rochet, Paul Woolley, 21 August 2014
The Global Crisis has intensified debates over the merits of financial innovation and the optimal size of the financial sector. This column presents a model in which the growth of finance is driven by the development of a financial innovation. The model can help explain the securitised mortgage debacle that triggered the latest crisis, the tech bubble in the late 1990s, and junk bonds in the 1980s. A striking implication of the model is that regulation should be toughest when finance seems most robust and when innovations are waxing strongly.
Kris James Mitchener , Kirsten Wandschneider, 18 August 2014
The IMF has recently revised its position on capital controls, acknowledging that they may help prevent financial crises. This column examines the effects of capital controls imposed during the Great Depression. Capital controls appear not to have been successfully used as tools for rescuing banking systems, stimulating domestic output, or for raising prices. Rather they appear to have been maintained as a means for restricting trade and repayment of foreign debts.
Nicola Gennaioli, Alberto Martin, Stefano Rossi, 19 July 2014
There is growing concern – but little systematic evidence – about the relationship between sovereign default and banking crises. This column documents the link between public default, bank bondholdings, and bank loans. Banks hold many public bonds in normal times (on average 9% of their assets), particularly in less financially developed countries. During sovereign defaults, banks increase their exposure to public bonds – especially large banks, and when expected bond returns are high. At the bank level, bondholdings correlate negatively with subsequent lending during sovereign defaults.
Pierre-Cyrille Hautcoeur, Angelo Riva, Eugene N. White, 02 July 2014
The key challenge for lenders of last resort is to ameliorate financial crises without encouraging excessive risk-taking. This column discusses the lessons from the Banque de France’s successful handling of the crisis of 1889. Recognising its systemic importance, the Banque provided an emergency loan to the insolvent Comptoir d’Escompte. Banks that shared responsibility for the crisis were forced to guarantee the losses, which were ultimately recouped by large fines – notably on the Comptoir’s board of directors. This appears to have reduced moral hazard – there were no financial crises in France for 25 years.
Marcus Miller, Lei Zhang, 26 June 2014
Like banks, indebted governments can be vulnerable to self-fulfilling financial crises. This column applies this insight to the Eurozone sovereign debt crisis, and explains why the ECB’s Outright Monetary Transactions policy reduced sovereign bond spreads in the Eurozone.
Jon Danielsson, Kevin James, Marcela Valenzuela, Ilknur Zer, 08 June 2014
Risk forecasting is central to financial regulations, risk management, and macroprudential policy. This column raises concerns about the reliance on risk forecasting, since risk forecast models have high levels of model risk – especially when the models are needed the most, during crises. Policymakers should be wary of relying solely on such models. Formal model-risk analysis should be a part of the regulatory design process.
Giovanni Cespa, Xavier Vives, 22 April 2014
Since capital flows to and from hedge funds are strongly related to past performance, an exogenous liquidity shock can trigger a vicious cycle of outflows and declining performance. Therefore, ‘noise’ trades – usually thought of as erratic – may in fact be persistent. Based on recent research, this column argues that there can be multiple equilibria with different levels of liquidity and informational efficiency, and that the high-information equilibrium can under certain conditions be unstable. The model provides a lens through which to interpret the ‘Quant Meltdown’ of August 2007 and the recent financial crisis.
Stijn Claessens, 18 April 2014
Stijn Claessens talks to Viv Davies about the recent IMF book titled 'Global Crises: Causes, Consequences and Policy Responses', co-edited with M Ayhan Kose, Luc Laeven, and Fabian Valencia. The book provides a comprehensive overview of current research into financial crises and the policy lessons learned. They discuss crisis prevention and management, and the crisis in the Eurozone. The interview was recorded in April 2014.
Matthieu Bussière, Gong Cheng, Menzie D. Chinn, Noëmie Lisack, 16 March 2014
The financial crisis that swept the global economy at the end of 2008 provides a natural experiment to test the proposition that international reserves are useful during crises. This column presents cross-country evidence based on a panel of 112 emerging and developing countries. Countries with more reserves relative to short-term debt fared better.
Petra Gerlach-Kristen, Rossana Merola, Conor O'Toole, 01 December 2013
Households tend to smooth their consumption and that’s why expenditures do not display a large variability over time. However, the recent financial crisis has been associated with a large decrease in consumption in certain countries. This column presents evidence that a drop in income during a crisis leads to a lower short-run consumption. Furthermore, micro data analysis shows that some households are affected more than others. Thus, policy recommendations can be made only after taking household heterogeneity into account.
Carlos Álvarez-Nogal, Christophe Chamley, 21 October 2013
The recent showdown over the US debt ceiling can be thought of as a game of chicken over the repayment of sovereign debt, with potentially severe consequences. This column describes an analogous historical episode in Spain, in which city delegates in the Cortes resisted tax increases, and Phillip II responded by suspending payments on a portion of the sovereign debt. By the time the cities caved to a doubling of their tax contribution two years later, the resulting bank failures and credit freeze had caused lasting economic damage.
Òscar Jordà, Moritz Schularick, Alan Taylor, 18 October 2013
In the aftermath of the global financial crisis, few would dispute the risks of excessive borrowing. But which debts should one worry about – public or private? This column presents new research on the interplay of public and private debts since 1870 in 17 advanced economies. History demonstrates that excessive private-sector borrowing plays a greater role than fiscal profligacy in generating financial instability. However, when the credit boom collapses, the government’s capacity to alleviate the downturn is limited by the prevailing level of public debt.
Peter N. Gal, Gabor Pinter, 21 September 2013
Renting capital goods makes up 20% of total capital expenses by US companies and this type of capital spending increases in downturns. This column discusses research showing that the systematic pattern of corporate leasing can be linked to credit constraints. This means that a robust rental sector has the potential to mitigate the negative effects of financial disruptions when obtaining credit becomes difficult.