Causes of Financial Crises (Financial Economics)

This is a recording of a revision webinar exploring some of the causes of financial crises in developed and emerging market countries.

There are many different types of crises ranging from currency/external debt crises to disturbances in banking systems. There is rarely a single cause of a crisis, most are the result of a combination of complex factors involving a range of market, policy and regulatory failures.

Summary of key causes

Financial market failures

• Irrational exuberance among agents (Shiller)
• Increased complexity arising from financial innovation
• Minsky hypothesis – stability breeds instability

Policy failures

• Unintended consequences of financial deregulation
• Banks too big to fail? Risky behaviour due to moral hazard?
• Interest rates too low for too long (e.g. USA, EZ 2002-2007)
• Large models of the economy which assume agents (businesses and consumers) always behave rationally
• Failures of ratings agencies in pricing risk accurately

Structural changes in the global economy

• Economic imbalances including global savings glut and low real interest rates
• Media and modern communications – immediate feedback