- | Thursday, November 19
- 12:15 PM
- Kaiserplatz 7-9, 4th floor, Room 4.006
Fiscal and Financial Crises
with Michael Bordo.
In this paper we examine the interconnections between financial and fiscal crises based on history, theory, and empirics. Section 2 presents a brief historical overview of financial crises. Section 3 surveys theoretical perspectives on financial crises. Banking crises traditionally were analyzed using three approaches: the monetarist approach, the financial fragility approach and the business cycle approach. Modern perspectives build upon these earlier theories. The key approach is based on the Diamond and Dybvig (1983) notion of the inherent instability of banking because of a maturity mismatch. Also seminal are theories based on asymmetric information. Section 4 provides empirical perspectives. We discuss the methodological issue of crisis measurement (the definition, dating and incidence) of financial crises. Different approaches to definition and dating in the literature lead to very different patterns of incidence and hence very different interpretations of the historical record. We also discuss the many and varied causes or determinants of financial crises, including bank credit driven asset booms which have resonance for the recent crisis. Our reading of the literature is that it is very difficult to predict crises with a high level of accuracy both because of Goodhart’s law as well as because of the complex economic eco-system represented by the financial sector. We then review measures of the output costs of financial crises including a look at the depth and duration of crises. Again different approaches in the literature lead to significantly different conclusions and hence different perspectives on the economic importance of crises. Section 5 contains a preliminary examination of the empirical connection between financial and fiscal crises and identifies a potential new Trilemma.