## _wp1328

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### I. Introduction: scope and objectives
- The 2007-09 global financial crisis underscored crises' multifaceted nature and wide reach; Reinhart and Rogoff (2009a) — “financial crises are an equal opportunity menace.”
- Key characteristics emphasized:
  - Domestic or external origins; private or public sector sources.
  - Asset and credit booms that turn into busts frequently precede financial crises.
  - Crises often require immediate and comprehensive policy responses and sometimes global coordination.
- Paper objective: focused survey addressing three questions:
  - What are the main factors explaining financial crises?
  - What are the major types of financial crises?
  - What are the real and financial sector implications of crises?
- Also: brief review of literature on prediction of crises and early warning models.

### II. Factors explaining financial crises
- Core mechanisms and features:
  - Substantial changes in credit volume and asset prices.
  - Severe disruptions in financial intermediation, notably supply of external financing.
  - Large-scale balance sheet problems (firms, households, financial intermediaries, sovereigns).
  - Large-scale government support (liquidity support and recapitalization).
- Literature focus: sharp movements in asset and credit markets are central to crisis origins.
- Empirical/contextual pointers:
  - Asset and credit booms often precede crises; explaining persistence of booms until unsustainability remains challenging.

### III. Classification: major types of crises
- Four-group useful classification:
  - Currency crises.
  - Sudden stop (capital account or balance-of-payments) crises.
  - Debt crises.
  - Banking crises.
- Note: Many crises overlap across types; overlap complicates classification and identification.

### IV. Identification and dating: methods and ambiguity
- Identification challenges:
  - Currency (and inflation) crises and sudden stops more amenable to quantitative identification.
  - Debt and banking crises typically rely on qualitative/judgmental analyses.
  - Coincidence and overlap among crisis types common.
- Common quantitative thresholds/criteria reported:
  - Reinhart and Rogoff: exchange rate depreciations in excess of 15 percent per year; inflation threshold 20 percent per year.
  - Frankel and Rose: depreciation of at least 25 percent cumulative over 12 months and at least 10 percentage points greater than in preceding 12 months.
  - Calvo, Izquierdo and Mejía (2008) sudden stop criteria: year-on-year fall in capital flows at least two standard deviations below its sample mean; episode starts/ends when annual change in capital flows falls/exceeds one standard deviation below/above its mean.
  - Cardarelli, Kose and Elekdag (2010) abrupt end definition: net private capital inflows to GDP in the year after the episode terminates is more than 5 percentage point lower than at the end of the episode.
- Dating ambiguity examples: differing dates for Japan’s banking crisis (1992 vs. 1997) and U.S. crisis chronologies across authors.

### V. Implications of financial crises — real effects (stylized facts and magnitudes)
- Recession characteristics:
  - Average duration of a recession associated with a financial crisis: some six quarters (two more than a normal recession).
  - Laeven and Valencia (2012): cumulative cost of banking crises is on average about 23 percent of GDP during the first four years.
  - Median output loss: advanced countries about 33 percent; emerging markets about 26 percent.
  - Examples where output losses exceed 100 percent: Iceland and Ireland.
- Medium- and long-term:
  - Abiad and others (2013): seven years after a banking crisis, level of output typically about 10 percent lower relative to precrisis trend.
- Fiscal effects:
  - Government debt on average rises by 86 percent during the three years following a banking crisis (Reinhart and Rogoff (2009a)).
  - Laeven and Valencia (2013): median increase in public debt about 12 percent for 147 systemic banking crises.
  - Fiscal costs, net of recoveries, associated with banking crises on average about 6.8 percent of GDP; can be as high as 57 percent of GDP; several cases over 40 percent of GDP.
  - Net resolution costs: emerging markets about 10 percent vs. advanced countries 3.8 percent.
  - Including indirect fiscal costs: recent crises in advanced countries overall fiscal costs 21.4 percent vs. 9.1 percent of GDP for emerging markets.
- Distributional and global impacts:
  - Consumption, investment, industrial production, employment, exports and imports decline markedly in crises.
  - The global financial crisis produced a 2 percent decline in world per capita GDP in 2009 (compared with declines of 0.8 percent in 1982 and 0.2 percent in 1991).

### VI. Implications of financial crises — financial effects (stylized facts and magnitudes)
- Typical asset and credit changes in advanced-country sample:
  - Credit declines by about 7 percent during credit crunches.
  - House prices fall by about 12 percent during house price busts.
  - Equity prices drop by more than 15 percent during equity price busts.
- Crunches and busts intensity and duration:
  - Credit crunches and house price busts lead to roughly 10 and 15 times larger drops than other downturns, respectively.
  - Equity busts are more than 2.5 times as large as other downturns.
  - Durations: house price busts last about 18 quarters; credit crunch and equity busts last about 10-12 quarters.
  - Equity price busts are three times more violent (slope coefficients) than credit and house price busts.
- Creditless recoveries:
  - Abiad, Dell’Ariccia, and Li (2013): about one out of five recoveries is creditless.
  - Average GDP growth during creditless recoveries is about a third lower than during “normal” recoveries.
- Micro/sectoral impacts: reductions in investment, R&D and employment; sectors dependent on external finance are curtailed more.

### VII. Asset-price and credit booms: triggers, amplifiers and outcomes
- Empirical triggers/amplifiers of credit booms:
  - Positive productivity shocks and buoyant growth: in the three-year period preceding a boom, average real GDP growth rate reaches 5.1 percent, compared to 3.4 percent during a tranquil three-year period (Dell’Ariccia and others (2013)).
  - Sharp increases in international financial flows can amplify local credit booms (Claessens et al. 2010).
  - Accommodative monetary policies linked to credit booms (evidence: low interest rates in the U.S. during 2001-04 associated with housing price rises and household leverage).
  - Structural factors: financial liberalization/innovation; roughly a third of booms identified follow or coincide with financial liberalization episodes (Dell’Ariccia and others (2013)).
  - Institutional weaknesses and competitive pressures can lower lending standards and increase fragility.
- Booms and busts empirical patterns:
  - Booms: slope two to three times larger than regular upturns.
  - Many booms do not end in crises: Dell’Ariccia et al (2012) — about a third of boom cases end in financial crises.
  - Dell’Ariccia and others (2013): close to half or more of booms with certain extreme features end up in crises (examples preserved exactly):
    - lasted longer than six years (4 out of 9),
    - exceeded 25 percent of average annual growth (8 out of 18),
    - started at an initial credit-to-GDP ratio higher than 60 percent (15 out of 26).
  - Twin booms (real estate plus credit) markedly raise systemic risk: in a 40-country sample, almost all countries with “twin booms” in real estate and credit markets (21 out of 23) suffered either a crisis or a severe drop in GDP growth relative to 2003–07; of seven countries with real estate booms but not credit booms, only two went through a systemic crisis on average.

### VIII. Types of crises: theoretical generations and empirical notes
- Currency crises: three generations of models
  - First generation: speculative attacks due to fiscal/monetary financing of deficits (Krugman 1979; Flood and Garber 1984).
  - Second generation: multiple equilibria and self-fulfilling attacks (Obstfeld and Rogoff 1986).
  - Third generation: balance-sheet deteriorations and financial sector vulnerabilities (motivated by Asian crises).
  - Empirical dating/thresholds: Reinhart and Rogoff (15 percent/year depreciation; 20 percent/year inflation); Frankel and Rose (25 percent cumulative depreciation over 12 months and at least 10 percentage points greater than prior 12 months).
- Sudden stops:
  - Emphasize disruptions in external financing and balance-sheet mismatches (Calvo et al., 2006).
  - More likely in countries with small tradable sectors and large foreign-exchange liabilities.
- Debt crises:
  - Models use intertemporal or intratemporal sanctions to explain sovereign default incentives.
  - Empirical puzzles: models underpredict defaults; Tomz and Wright (2007) — in only 62 percent of default cases output was below trend.
  - Debt intolerance: external debt above 30-35 percent of GNP raises likelihood of external debt crisis substantially (Reinhart and Rogoff, 2009b).
- Banking crises:
  - Fragility from maturity transformation and leverage; coordination failures and runs can be self-fulfilling (Diamond and Dybvig, 1983).
  - Safety nets mitigate runs but can introduce moral hazard.
  - Recent crisis drivers: complex/opaque financial instruments, increased interconnectedness, high leverage, central role of the household sector.
  - Structural contributors: poor market discipline, excessive deposit insurance/moral hazard, weak disclosure, weak corporate governance, poor supervision, large state-ownership, limited competition, undiversified systems.

### IX. Predicting crises: main challenges and empirical indicators
- Fundamental difficulties:
  - Timing prediction very difficult due to market fickleness and crises of confidence.
  - Nature of crises evolves; early warning tools can become obsolete.
- Key empirical indicators and findings:
  - Rapid credit and asset price growth most reliably related to financial stress.
  - Borio and Lowe (2002): almost 80 percent of crises can be predicted on the basis of a credit boom at a one-year horizon, with false positive signals about 18 percent of the time.
  - Dell’Ariccia et al (2012): only about a third of boom cases end up in financial crises.
  - Frankel and Saravelos (2012) meta-analysis: growth rate of credit, foreign exchange reserves, the real exchange rate, GDP growth, and current account to GDP are frequently significant.
  - Global factors (terms of trade, world interest rates, commodity prices) can trigger crises.
  - Practical early warning systems: combine quantitative leading indicators across external, public, financial, nonfinancial corporate, and household sectors with qualitative inputs; international measures such as non-core to core liabilities ratios flag vulnerabilities.
- Predictive limitations:
  - Asset price busts especially hard to predict; best indicators failed to raise alarms one to three years ahead of roughly one-half of all busts since 1985.

### X. Policy and research implications (prevention and mitigation)
- Prevention: monitoring and policy design
  - Monitor asset and credit booms, especially twin booms in real estate plus credit.
  - Strengthen regulation and supervision to keep pace with financial innovation; ongoing reforms include Basel III elements (well capitalized and liquid banks, transparency, sound accounting).
  - Macro-prudential policies: potential to reduce externalities and improve stability, but design and interactions (notably with monetary policy) remain unclear.
  - Monetary policy debate:
    - Pre-crisis: consider asset prices only to the extent they forecast inflation/outlook.
    - Post-crisis: view that monetary policy should incorporate asset price developments to some degree (Blanchard, Dell’Ariccia and Mauro, 2009; Bernanke, 2009 and 2011; Trichet, 2009).
    - Operationalization remains unresolved (Eichengreen et al. 2011; Mishkin, 2011).
  - Need for better macro models reflecting financial intermediaries, liquidity and leverage dynamics, and supply side of finance.
- Mitigation: crisis response and resolution
  - Many crises involve solvency problems; liquidity support and guarantees cannot substitute for proper restructuring and recapitalization.
  - Sooner restructuring in banking crises tends to produce better outcomes by removing residual uncertainty.
  - Restructuring household and sovereign debt needs more sophisticated theoretical and empirical approaches.
  - Disagreement in literature on efficacy of countercyclical/expansionary policies (mixed empirical findings; fertile ground for research).
- Research priorities:
  - Overcome “this-time-is-different” syndrome via richer data and novel methodologies.
  - Two major questions: How to prevent financial crises? How to mitigate their costs when they take place?
  - Intensify data collection and develop methods to guide empirical and theoretical studies.
  - Explore financial spillovers and contagion mechanisms, including new financial channels (commercial paper conduits, shadow banking) and trade channels (vertical trade networks).
  - Study interactions and overlapping crises (e.g., sovereign-default–banking crisis links) and domestic vs. external debt dynamics.

### XI. Data and methodological needs
- Urgent data priorities:
  - Better data on domestic debt.
  - Better data on house prices.
  - Better (international) data for surveillance and early warning exercises.
- Methodological needs:
  - Design new methods to classify crises more robustly.
  - Examine financial disruption episodes that did not become crises as counterfactuals.
  - Improve early warning models and macrofinancial models to capture liquidity, leverage, and financial intermediary behavior.

*Source: _wp1328 (PDF chapter/section) — summary of references, methods for predicting crises, empirical findings, and policy/research implications.*

### References .............................................................................................................

### _wp1328 - References

### I. Introduction
- Context:
  - The 2007-09 global financial crisis highlighted the multifaceted nature of crises and their wide reach across small and large, poor and rich countries.
  - Quotation: Reinhart and Rogoff (2009a) — “financial crises are an equal opportunity menace.”
- Key characteristics of crises noted:
  - Domestic or external origins; private or public sector sources.
  - Different shapes and sizes; evolving forms; potential for rapid cross-border spread.
  - Often require immediate and comprehensive policy responses, major changes in financial sector and fiscal policies, and sometimes global coordination.
- Paper objective:
  - A focused survey addressing three specific questions:
    - What are the main factors explaining financial crises?
    - What are the major types of financial crises?
    - What are the real and financial sector implications of crises?
  - Brief review of the literature on prediction of crises and early warning models.

### II. Factors explaining financial crises
- Overview:
  - Financial crises are often an amalgam of events: substantial changes in credit volume and asset prices, severe disruptions in financial intermediation (notably supply of external financing), large-scale balance sheet problems, and the need for large-scale government support.
  - Asset and credit booms that turn into busts frequently precede financial crises.
- Literature focus:
  - Theories and empirical studies emphasize sharp movements in asset and credit markets as central to understanding crisis origins.
- Reference guidance:
  - For further reading: Reinhart and Rogoff (2009) as the starting point; classical references include Minsky (1975) and Kindleberger (1976). Additional reviews cited: IMF (1998), Eichengreen (2002), Tirole (2002), Allen and Gale (2007), Allen, Babus, Carletti (2009), Allen (2009), and Gorton (2012).

### III. Classification: Major types of financial crises
- Useful four-group classification:
  - Currency crises.
  - Sudden stop (or capital account or balance of payments) crises.
  - Debt crises.
  - Banking crises.
- Notes on classification:
  - Section summarizes analytical causes and empirical determinants for each type.
  - Many crises overlap across types (e.g., banking crises often associated with sudden stops and currency crises), complicating classification and identification.

### IV. Identification of crises
- Identification challenges:
  - Theories guide identification methods, but translating theoretical predictions into practice is difficult.
  - Currency (and inflation) crises and sudden stops can be identified with quantitative methods more readily.
  - Debt and banking crises identification typically relies on qualitative and judgmental analyses.
- Coincidence and overlap:
  - Different crisis types frequently overlap, creating further identification challenges.
- Literature approach:
  - A wide range of methods is employed to identify and classify crises.
  - The section reviews the frequency of crises over time and across different country groups.

### V. Implications of financial crises
- Macroeconomic and financial implications:
  - Crises typically have severe macroeconomic and financial consequences with many commonalities across types.
  - Large output losses are common across many crises.
  - Other macroeconomic variables generally register significant declines.
  - Financial variables such as asset prices and credit usually follow qualitatively similar patterns across crises, with variations in duration and severity.
- Scope of analysis:
  - The section examines short- and medium-run effects and presents stylized facts regarding macroeconomic and financial implications.
- Figures referenced (list preserved from source):
  - Figure 1. Evolution of House Price During Financial Crises (page 56)
  - Figure 2a. Credit and Asset Price Booms (page 57)
  - Figure 2b. Credit Crunches and Asset Price Busts (page 58)
  - Figure 3. Coincidence of Financial Booms and Crises (page 59)
  - Figure 4. Coincidence of Financial Crises (page 60)
  - Figure 5. Average Number of Financial Crises over Decades (page 61)
  - Figure 6. Coincidences of Recessions and Crises (page 62)
  - Figure 7. Real Implications of Financial Crises, Crunches, and Busts (page 63)
  - Figure 8. Financial Implications of Crises, Crunches, and Busts (page 64)
  - Figure 9. Creditless Recoveries (page 65)

*Source: _wp1328 - References (PDF chapter/section).*

### Section VI summarizes the main methods used for predicting crises. It has been a challenge

### _wp1328 - Section VI summarizes the main methods used for predicting crises. It has been a challenge

### Predicting crises: main challenges and research priorities
- Predicting the exact timing of crises is very difficult because financial markets with high leverage can be subject to crises of confidence; fickleness is the main reason why timing is hard to predict.
- The nature of crises changes over time as economic and financial structures evolve; early warning tools can quickly become obsolete or inadequate.
- Future research priorities (as summarized):
  - Gear future research to eliminate the “this-time-is-different” syndrome.
  - Address two major questions: How to prevent financial crises? And, how to mitigate their costs when they take place?
  - Intensify efforts to collect necessary data and to develop new methodologies to guide empirical and theoretical studies.

### Key features and mechanisms of financial crises
- Financial crises are multidimensional and often associated with one or more of:
  - substantial changes in credit volume and asset prices;
  - severe disruptions in financial intermediation and the supply of external financing;
  - large scale balance sheet problems (firms, households, financial intermediaries and sovereigns);
  - large scale government support (liquidity support and recapitalization).
- Causes are hard to definitively identify; both fundamental factors (macroeconomic imbalances, internal/external shocks) and “irrational” factors (sudden runs on banks, contagion, limits to arbitrage, fire-sales) are documented.
- Asset and credit booms often precede crises; explaining why bubbles and booms continue until they become unsustainable remains challenging.

### Asset price booms and busts: mechanisms and empirical patterns
- Definition used: a bubble is “the part of a grossly upward asset price movement that is unexplainable based on fundamentals” (Garber, 2000).
- Theories explaining bubbles include:
  - Rational-expectations “rational” bubbles (e.g., Blanchard and Watson (1982)).
  - Learning models where recent data bias expectations (e.g., Branch and Evans (2008)).
  - Microeconomic distortions (agency issues, risk shifting, limits to arbitrage).
  - Behavioral/market-friction mechanisms (herding, informational cascades, market sentiment).
- Busts can be triggered by small shocks; information asymmetries and adverse feedback loops (fire sales, forced liquidations) can magnify small price declines into crises.
- Flight to quality exacerbates turmoil as investors prefer “low information-intensive” debt claims in normal times but require heavy information processing during turmoil, deepening price declines for lower-quality debt.

### Credit booms and busts: triggers and amplifiers
- Credit booms commonly precede crises; leverage buildups and rapid credit expansion often occur with asset price increases.
- Triggers and amplifiers of credit booms:
  - Positive productivity shocks and buoyant growth: in the three-year period preceding a boom, average real GDP growth rate reaches 5.1 percent, compared to 3.4 percent during a tranquil three-year period (Dell’Ariccia and others (2013)).
  - Sharp increases in international financial flows can amplify local credit booms (Claessens et al. 2010).
  - Accommodative monetary policies, especially when prolonged, are linked to credit booms and excessive risk-taking; evidence includes low interest rates in the U.S. during 2001-04 cited as a factor behind housing price rises and household leverage.
  - Structural factors: financial liberalization and innovation can trigger booms; roughly a third of booms identified follow or coincide with financial liberalization episodes (Dell’Ariccia and others (2013)).
  - Institutional weaknesses and competitive pressures can lead to a decline in lending standards and increased fragility.

### Impact of asset-price and credit busts: magnitudes and durations
- Booms are shorter, stronger, and faster than normal upturns; the slope of a typical boom is two to three times larger than that of regular episodes.
- Crunches and busts are longer, deeper, and more violent than other downturns:
  - Credit crunches and house price busts lead to respectively roughly 10 and 15 times larger drops than other downturns.
  - Equity busts are more than 2.5 times as large as other downturns.
  - Durations: house price busts last about 18 quarters; credit crunch and equity busts last about 10-12 quarters.
  - Busts in equity prices are three times more violent (slope coefficients) than those in credit and house prices (Claessens, Kose and Terrones, 2010a).
- Booms financed through banks and involving housing entail larger systemic risks; in a 40-country sample, almost all countries with “twin booms” in real estate and credit markets (21 out of 23) suffered either a crisis or a severe drop in GDP growth relative to 2003–07; of seven countries with real estate booms but not credit booms, only two went through a systemic crisis on average.

### Types of financial crises and theoretical generations
- Two broad classification approaches: strictly quantitative definitions (currency and sudden-stop crises) and qualitative/judgmental analysis (debt and banking crises).
- Currency crises:
  - Three generations of models:
    - First generation (KFG): speculative attacks on pegged currencies due to fiscal/monetary financing of deficits (Krugman 1979; Flood and Garber 1984).
    - Second generation: multiple equilibria and self-fulfilling attacks (Obstfeld and Rogoff 1986).
    - Third generation: balance-sheet deteriorations and financial sector vulnerabilities (motivated by Asian crises).
  - Empirical dating examples/thresholds:
    - Reinhart and Rogoff use exchange rate depreciations in excess of 15 percent per year as a crisis threshold; inflation threshold of 20 percent per year.
    - Frankel and Rose define a crisis as a depreciation of at least 25 percent cumulative over a 12-month period, and at least 10 percentage points greater than in the preceding 12 months.
  - Empirical work has not decisively favored any single generation of models; structural tests have had mixed success.
- Sudden stops:
  - Emphasize disruptions in external financing and balance-sheet mismatches (Calvo et al., 2006).
  - Recent models incorporate frictions (financial accelerators, Fisherian debt-deflation) to generate output drops consistent with observed crises dynamics.
  - Sudden stops are more likely in countries with small tradable sectors and large foreign-exchange liabilities.
  - Empirical identification criteria (Calvo, Izquierdo and Mejía (2008)):
    - A year-on-year fall in capital flows at least two standard deviations below its sample mean.
    - Episode starts/ends when annual change in capital flows falls/exceeds one standard deviation below/above its mean.
- Foreign and domestic debt crises:
  - Models rely on intertemporal sanctions (loss of future lending) or intratemporal sanctions (trade cutoffs) to explain sovereign lending and default incentives.
  - Empirical puzzles: models often underpredict defaults; in only 62 percent of default cases output was below trend (Tomz and Wright (2007)).
  - Debt intolerance: when external debt level of an emerging economy is above 30-35 percent of GNP, the likelihood of an external debt crisis rises substantially (Reinhart and Rogoff, 2009b).
  - Financing choices are endogenous; short-term foreign-exchange debt may be both a commitment device and a necessary (but risky) funding source for some countries.
- Banking crises:
  - Banks’ maturity transformation and leverage make them fragile; coordination problems and runs can be self-fulfilling (Diamond and Dybvig, 1983).
  - Safety nets (deposit insurance, lender-of-last-resort) and microprudential regulation can mitigate runs but can also introduce moral hazard and distort incentives.
  - Historical patterns: widespread bank runs in the U.S. ended after deposit insurance in 1933; runs still occurred in 1997 Asian crisis and Northern Rock run in the U.K.
  - Structural contributors: poor market discipline, excessive deposit insurance and moral hazard, limited disclosure, weak corporate governance, poor supervision, large state-ownership, limited competition, and undiversified financial systems.
  - Recent crisis common features: (1) asset price increases that turned out to be unsustainable; (2) credit booms that led to excessive debt burdens; (3) build-up of marginal loans and systemic risk; (4) failure of regulation and supervision to keep up with financial innovation.
  - New factors in the recent global crisis: (1) widespread use of complex and opaque financial instruments; (2) increased interconnectedness among financial markets, nationally and internationally, with the U.S. at the core; (3) high degree of leverage of financial institutions; (4) central role of the household sector.

### Identification, dating and frequency: methods and ambiguity
- Identification methods vary by crisis type:
  - Currency and inflation crises often use quantitative thresholds (examples above).
  - Composite indexes of speculative pressure combine exchange rate changes, international reserves movements and interest rate movements with weights chosen to equalize variances of components.
  - Sudden stops and balance-of-payments crises use capital-flow reversal criteria and output collapse correlations (Calvo et al., 2004; Calvo, Izquierdo and Mejía, 2008).
  - Debt and banking crises dating frequently rely on qualitative and judgmental analysis.
- Methodological choices (thresholds, sample-specific vs universal thresholds) change dating results; overlap among crisis types adds classification ambiguity.
- Frequency and types of crises have evolved over time: currency crises dominant in the 1980s; banking crises and sudden stops more prevalent in the 1990s and 2000s.

### Policy and research implications emphasized in the section
- Empirical and theoretical research must:
  - Focus on preventing crises and mitigating costs when crises occur.
  - Overcome the “this-time-is-different” bias by collecting richer data and developing new methodologies.
  - Recognize the multidimensional nature of crises and that single indicators rarely capture full systemic risk.
- Policy measures highlighted implicitly by the literature:
  - Monitor asset and credit booms, especially when jointly present (real estate plus credit), as twin booms are associated with high systemic risk.
  - Strengthen regulation and supervision in pace with financial innovation to limit moral hazard and fragility.
  - Consider macroprudential tools to address leverage and lending standards loosened during booms.
  - Maintain data collection and analytic capacity to update early-warning tools, given the rapid evolution of financial structures.

*Source: _wp1328 — Section VI summary of methods for predicting crises and related discussion.*

### introduction of a brand new currency replacing a much-depreciated earlier currency in circulation as

### _wp1328 - introduction of a brand new currency replacing a much-depreciated earlier currency in circulation as

### Identification and dating of crises
- Dating crises varies by type and methodology; common indicators include:
  - Large spikes in the Emerging Markets Bond Index (EMBI) spread.
  - A fall in output (used in some studies, later replaced by EMBI spikes because output falls may be endogenous).
  - Cardarelli, Kose and Elekdag (2010) define an abrupt end to a large capital inflow episode if the ratio of net private capital inflows to GDP in the year after the episode terminates is more than 5 percentage point lower than at the end of the episode.
  - An episode may also be considered to finish abruptly if its end coincides with a currency crisis.
- Balance-of-payments crises, external sovereign debt crises, domestic debt crises, and banking crises have specific dating challenges:
  - Sovereign defaults are identified by defaults on payments, rating agency classifications, or international financial institution information; choices remain over magnitude, type, and length of default.
  - The end of default can be dated by regained access to private financial markets or recovery of a certain credit rating.
  - Domestic debt crises were historically harder to identify due to missing consistent historical data and diverse default forms (outright defaults; hyper- or high inflation; punitive taxation of interest payments; forced interest rate or principal adjustments or conversions; gold clause abrogation; debasing of currency; financial repression).
  - Banking crises are dated qualitatively by events (forced closures, mergers, government takeover, runs, extension of government assistance) and by fiscal costs or in-depth financial-condition assessments; ends are hard to identify because effects can linger.
- Different studies show substantial overlap but also differences in dating (examples include Japan’s banking crisis dated 1992 by Reinhart and Rogoff (2009a) vs. 1997 by Laeven and Valencia; U.S. crises chronology differs across authors), underscoring dating importance.

### Frequency and distribution of crises
- Crises afflicted both emerging markets and advanced countries across centuries; the three decades before 2007 saw most crises in emerging markets, but advanced countries have also experienced recent crises.
- Some argue crises became more frequent after WWII; reasons include more liberalized financial markets, floating exchange rates, and greater financial integration.
- Median durations and relative frequencies:
  - Currency and sudden stop crises are relatively short (almost by definition).
  - Banking crises tend to last the longest.
- Counts and overlaps (post Bretton Woods / 1970–2011 period reported by Laeven and Valencia (2013)):
  - 147 banking crises.
  - 217 currency crises.
  - 67 sovereign debt crises.
  - Of the 431 banking (147), currency (217) and sovereign (67) crises, 68 are considered twin crises, and 8 can be classified as triple crises.
  - Of 67 sovereign crises, 20 are also a banking crisis and 42 are also a currency crisis.
- Crises often come in bunches (examples and historical clustering identified, including five major periods for now-advanced countries: 1893, the early 1890s, 1907, 1930-31, and 2007-08).

### Real effects of crises
- Crises have large effects on economic activity and can trigger recessions:
  - The average duration of a recession associated with a financial crisis is some six quarters, two more than a normal recession.
  - Laeven and Valencia (2012) estimate that the cumulative cost of banking crises is on average about 23 percent of GDP during the first four years.
  - Median output loss for advanced countries is about 33 percent; for emerging markets it is 26 percent.
  - Examples where output losses exceed 100 percent (Iceland and Ireland).
- Aggregate and distributional macroeconomic impacts:
  - Recessions following crises exhibit much larger declines in consumption, investment, industrial production, employment, exports and imports.
  - In emerging markets, the decline in consumption during recessions associated with financial crises is typically seven to ten times larger than those without such crises.
- Global impacts:
  - The global financial crisis produced a 2 percent decline in world per capita GDP in 2009.
  - World per capita GDP declined by about 0.8 percent in 1982 and 0.2 percent in 1991.
- Medium- and long-term consequences:
  - Abiad and others (2013): seven years after a banking crisis, the level of output is typically about 10 percent lower relative to precrisis trend.
  - Output depressions associated with crises accompany long-lasting reductions in employment rate, capital-to-labor ratio, and total factor productivity.
- Fiscal effects:
  - Government debt on average rises by 86 percent during the three years following a banking crisis (Reinhart and Rogoff (2009a)).
  - Laeven and Valencia (2013) report median increase in public debt of about 12 percent for their sample of 147 systemic banking crises.
  - Gross and net fiscal costs:
    - Laeven and Valencia (2013): fiscal costs, net of recoveries, associated with banking crises are on average about 6.8 percent of GDP.
    - Fiscal costs can be as high as 57 percent of GDP and in several cases are over 40 percent of GDP (examples cited in text).
    - Net resolution costs tend to be higher for emerging markets, 10 percent vs. 3.8 percent for advanced countries.
    - Including indirect fiscal costs, recent crises in advanced countries show overall fiscal costs of 21.4 percent vs. 9.1 percent of GDP for emerging markets.

### Financial effects of crises
- Asset prices and credit typically decline sharply during crises:
  - In a large sample of advanced countries:
    - Credit declines by about 7 percent during credit crunches.
    - House prices fall by about 12 percent during house price busts.
    - Equity prices drop by more than 15 percent during equity price busts.
- Credit supply contraction is a major drag on the real economy:
  - After banking crises, sectors more dependent on external financing grow more slowly; recoveries in output components often precede revival of credit growth and turnaround in house prices.
  - "Creditless recoveries" are common:
    - Abiad, Dell’Ariccia, and Li (2013): about one out of five recoveries is creditless.
    - Average GDP growth during creditless recoveries is about a third lower than during “normal” recoveries.
- Micro and sectoral impacts:
  - Financial crises are associated with reductions in investment, R&D and employment; firms pass up growth opportunities.
  - Sectors dependent on external finance and investment are curtailed more.

### Predicting financial crises
- Predictive challenge:
  - No single set of indicators consistently predicts all types of crises or their timing.
  - Early warning models evolved from macroeconomic imbalance focus to include balance sheet variables and combinations of indicators.
- Key predictors and empirical findings:
  - Cardarelli, Kose and Elekdag (2010) definition for abrupt end: net private capital inflows to GDP falls by more than 5 percentage point in the year after episode termination.
  - Early indicators for currency crises (monthly and annual) include: appreciation of real exchange rate relative to trend; decline in equity prices; fall in exports; high ratio of broad money (M2) to international reserves; recession; large current-account deficits relative to GDP and investment.
  - Subsequent models highlight balance-sheet variables such as substantial short-term debt coming due and the ratio of broad money to international reserves.
  - Frankel and Saravelos (2012) meta-analysis: growth rate of credit, foreign exchange reserves, the real exchange rate, GDP growth, and current account to GDP are frequently significant indicators.
  - Global factors (terms of trade, world interest rates, commodity prices) can trigger crises.
  - Rapid credit and asset price growth is most reliably related to financial stress:
    - Borio and Lowe (2002): almost 80 percent of crises can be predicted on the basis of a credit boom at a one-year horizon, with false positive signals about 18 percent of the time.
    - Dell’Ariccia et al (2012): only about a third of boom cases end up in financial crises; many booms lead to benign financial deepening.
    - Dell’Ariccia and others (2013): close to half or more of booms that either lasted longer than six years (4 out of 9), exceeded 25 percent of average annual growth (8 out of 18), or started at an initial credit-to-GDP ratio higher than 60 percent (15 out of 26) ended up in crises.
- Practical early warning systems:
  - Use a wide array of quantitative leading indicators on vulnerabilities in external, public, financial, nonfinancial corporate, and household sectors combined with qualitative inputs.
  - International measures such as exposures to international funding risks and the ratio of non-core to core liabilities help signal vulnerabilities.
  - The empirical relationship between international financial integration and crises is mixed and debated.

### Conclusions and policy implications
- Three central questions addressed:
  - What explains financial crises? Booms in asset and credit markets that turn into busts are central drivers; literature clarifies some factors but not definitive causes.
  - What are the major crisis types? Four major types emphasized: currency crises; sudden stop (capital account or balance of payments) crises; debt crises; and banking crises — with frequent overlaps.
  - What are real and financial implications? Large output losses, sharp declines in consumption, investment, industrial production, and large corrections in asset prices and credit.
- "This-time-is-different" syndrome persists:
  - Despite repeated commonalities in run-ups to crises (notably increases in credit and asset prices), policymakers often believe current booms are different and built on sound fundamentals.
  - Future research priorities highlighted:
    - How to prevent financial crises.
    - How to mitigate costs when crises occur.
    - More intensive efforts to collect necessary data to guide empirical and theoretical studies.

*Source: _wp1328 - introduction of a brand new currency replacing a much-depreciated earlier currency in circulation as (PDF chapter/section).*

### conclusion takes each of these issues in turn and points to future research directions.

### _wp1328 - conclusion takes each of these issues in turn and points to future research directions.

### How to prevent financial crises?
- Rapid increases in asset prices and credit can lead to financial turmoil and crises with significant adverse macroeconomic effects.
- Important to monitor vulnerabilities from sharp increases and determine if they could be followed by large and rapid declines (crashes, busts or crunches, capital outflows).
- Busts and crunches are likely to be more harmful if bubbles arise due to “distortions.”
- Evidence of irrationality can be interpreted as a sign of inefficiency and a potential source of welfare loss; bubbles and credit booms can call for interventions.
- Twofold challenge for policymakers and researchers:
  - Determine when (and to what extent) increases in asset prices and credit represent substantial deviations from those that can be explained by fundamentals.
  - If credit and asset markets suggest signs of risk, determine optimal policy responses to minimize risks and mitigate adverse effects when risks materialize.
- Debate on monetary policy response to asset prices and credit:
  - Pre-crisis consensus: consider asset prices only to the extent they forecast economic outlook and inflation (see Mishkin 2008, and Kohn 2008).
  - Post-crisis view: monetary policy should take into account to some degree developments in asset prices (Blanchard, Dell’Ariccia and Mauro, 2009; Bernanke, 2009 and 2011; Trichet, 2009).
  - How to operationalize remains under discussion (Eichengreen et. al 2011; Mishkin, 2011).
  - Case for intervention stronger when banking system directly finances the bubble; other asset price bubbles can more justifiably be left to themselves (Crowe et. al, 2011).
  - Exact adjustment of monetary policy remains unclear (Bean, Paustian, Penalver, and Taylor, 2010; King, 2012).
- Lessons needed about micro-prudential regulations and institutional structures:
  - Latest crisis exposed flaws in micro-prudential regulatory and institutional frameworks.
  - Global nature of crisis shows benefits and risks of financially integrated markets; international financial architecture still far from matching policy demands.
  - Ongoing reforms: well capitalized and liquid banks, transparency, sound accounting standards (e.g., Basel III).
  - Unclear how to deal with large, complex financial institutions across many borders.
  - Uncertainty about which institutional changes reduce procyclicality and systemic risks (e.g., accounting standards for mark-to-market valuation, adaptations of employee compensation rules, moves of some derivatives trading to formal exchanges, greater use of central counter parties).
  - Fiscal policies (micro and macro) can play a role in creating vulnerabilities; which adaptations are needed is not always clear.
- Macro-prudential policies:
  - Call for use of macro-prudential policies exists, but their design and interactions with other policies, especially monetary policy, remain unclear.
  - Macroprudential policies can reduce externalities and market failures and improve macroeconomic stability (De Nicolò and others (2012)).
  - Exact design is yet to be formulated; multiple tools are needed and complications abound.
  - Different financial distortions lead to different risks and imply multiple intermediate targets; distortions change over time and vary by country.
  - Factors such as development of financial sector and exchange rate regime can greatly affect risks.
  - Conceptual models and empirical evidence on macroprudential–monetary interactions are still at early stages (see IMF (2013) for a review).
- Need for better macroeconomic models:
  - Macroeconomic models need to better reflect roles of financial intermediaries; current models often limited in capturing financial frictions.
  - Many models assume available instruments can fully offset financial shocks and abstract from effects such as those of monetary policy on financial stability.
  - More realistic modeling of channels giving rise to financial instability and actual transmission of policies and instruments is needed.
  - Supply side of finance not well understood; models with realistic calibrations reflecting periods of financial turmoil are still missing (Brunnermeier and Sanikov, 2012).
  - Roles of liquidity and leverage in such periods need examination with models better suited to policy questions.
  - Empirical studies needed to help calibrate models and formulate policy prescriptions adaptable to different country circumstances.
- Need for better early warning models:
  - Predictive power of available models remains limited.
  - Historical record: asset price busts especially difficult to predict; even the best indicator failed to raise an alarm one to three years ahead of roughly one-half of all busts since 1985.
  - Recent papers on predicting the latest crisis reach mixed conclusions; scope exists to improve these models.
- Known risks being addressed can give rise to new risks:
  - Emerging markets increased international reserves since the late 1990s in response to financial globalization and sudden stop risks; this may have helped some countries avoid impact of the recent crisis (De Gregorio, 2013; Kose and Prasad, 2010).
  - Improvements in institutional environments over the last decades likely helped reduce some vulnerabilities.
  - New risks emerged in the latest crisis: explosion of complex financial instruments, greater balance-sheet opaqueness, and reliance on wholesale funding in highly integrated global financial markets.

### How to mitigate the costs of financial crises?
- Substantial real costs associated with crises remain a challenge to explain; why crises cause large costs remains an enigma.
- Various theories exist on channels by which different crises affect the real economy; many empirical descriptions of patterns around crisis episodes exist.
- Observed outcomes:
  - Normal lending seems undermined for extended periods, evidenced by creditless recoveries following crises.
  - Fiscal policy and public debt dynamics can be affected for decades as governments support financial systems (inject liquidity or recapitalize) or face expansionary policies to mitigate crisis costs.
- Major challenge: explain sharp, non-linear behavior of financial markets in response to “small” shocks.
  - Procyclicality of leverage among financial institutions increased during run up to the 2007-09 crisis followed by sharp deleveraging in its aftermath (Adrian and Shin, 2012).
  - Exact causes of this behavior yet to be identified.
  - Puzzle: why crises involve liquidity hoarding leading to aggregate liquidity shortages and disrupt transmission of monetary policy.
  - Credit crunches partly attributable to capital shortages at financial institutions, but capital shortages do not fully explain lenders becoming overly risk-averse after a crisis.
  - Lack of knowledge on forces shaping dynamics before and during financial stress complicates design of policy responses.
- Need to explore financial spillovers and contagion:
  - Why are spillovers across entities much more potent than fundamentals suggest?
  - Latest episode had global reach and depth without precedent in post–World War II period.
  - Research needed on transmission mechanisms through which episodes spill over to other countries, including roles of new financial channels (commercial paper conduits, shadow banking) and new trade channels (vertical trade networks).
  - For cross-border implications, pooling regional or global resources to provide ample liquidity proactively can avoid liquidity runs escalating into solvency crises and help break contagion chains.
- Interactions among different crises and sovereign debt defaults:
  - Various types of crises can overlap in a single episode; research on implications of overlapping crises is limited.
  - Default on domestic debt is less frequent than on external debt but still occurs often, suggesting assumption of risk-free government debt needs revisiting.
  - Interplays appear between domestic and foreign debt defaults.
  - Domestic debt often accounts for a large share of total debt stock in advanced countries and emerging markets, yet many emerging countries default on external debt at seemingly low thresholds of debt levels.
  - For a given level of unsustainable debt, cost of defaulting on external debt appears less than on domestic debt.
  - Tradeoffs likely depend on country circumstances, possibly because risk of high inflation varies.
  - With rising public debt stocks in many advanced countries, more work on these issues would be useful.
- Questions about best policy responses:
  - Limits of policy measures in dealing with financial meltdowns have been shown by global crisis and associated recessions.
  - Debate on efficacy of policies:
    - Some research: countercyclical policies might mitigate cost and reduce duration of recessions (Kannan, Terrones, and Scott, 2013).
    - Others argue such policies can worsen recession outcomes (Taylor, 2009 and 2011).
    - Some find limited effects associated with expansionary policies (Claessens, Kose, and Terrones, 2009; Baldacci, Gupta, Mulas-Granados, 2013).
  - Discussion indicates fertile ground for future research.
- Crisis resolution practices:
  - Open-bank assistance without proper restructuring and recapitalization is not efficient for dealing with ailing banking systems (Laeven and Valencia, 2013; Landier and Ueda, 2013).
  - Excessive liquidity support and guarantees of bank liabilities cannot substitute for proper restructuring and recapitalization; most banking crises involve solvency problems, not only liquidity shortfalls.
  - Sooner restructuring in banking crises leads to better outcomes by removing residual uncertainty that triggers precautionary contractions in consumption and investment and exacerbates recessions.
  - Despite understanding, many countries do not adopt these policy responses, including in some current crises (Claessens et al. 2013), suggesting deeper factors remain unexplored.
  - Restructuring of household debt and sovereign debt requires more sophisticated theoretical and empirical approaches (Laeven and Laryea, 2013; Das, 2013; Igan and others, 2013).

### What are the major needs for additional data and methods?
- Need to assemble new data series and design new methodologies to better understand crises episodes.
- Despite several recent studies assembling new data, further cross-country data collection on aspects relevant to financial crises is necessary.
- Urgent data needs:
  - Better data on domestic debt.
  - Better data on house prices to understand domestic debt dynamics and housing market fluctuations.
  - Better (international) data for both surveillance and early warning exercises (see Heath, 2013 and Cerutti, Claessens and McGuire, 2013, for data needs).
- Methodological needs:
  - Design new methods to classify crises in a more robust manner.
  - Examine periods of financial disruptions that are not necessarily crises; such disruption episodes (where good luck or adequate policy prevented a crisis) can provide case studies and counterfactuals to analyze macroeconomic outcomes and policy implications.

*Italic: Source — _wp1328 - conclusion takes each of these issues in turn and points to future research directions.*

### References

### _wp1328 - References

### Literature and Empirical Coverage
- Extensive bibliography covering theoretical and empirical work on financial crises, asset-price bubbles, banking regulation, sovereign debt, currency crises, credit booms, and macrofinancial stability.
- Key recurring topics and authors cited:
  - Financial crises theory and history: Abreu and Brunnermeier (2003); Kindleberger (1978, 1986); Minsky (1975, 1977); Fisher (1933).
  - Banking crises, systemic risk, and resolution: Laeven and Valencia (2008, 2013a, 2013b); Honohan and Laeven (eds.), 2007; Gorton (2008, 2009, 2012).
  - Credit booms, leverage, and macroeconomic effects: Jorda, Schularick, and Taylor (2012); Mendoza and Terrones (2008, 2012); Schularick and Taylor (2012).
  - Sovereign debt and defaults: Bulow and Rogoff (1989); Borensztein and Panizza (2009); Das, Papaioannou, and Trebesch (2012); Panizza, Sturzenegger, and Zettelmeyer (2009).
  - Early warning indicators, contagion, and capital flows: Kaminsky, Lizondo, and Reinhart (1998); Forbes (2012); Forbes and Warnock (2012); Goldstein, Reinhart, and Kaminsky (2000).
  - Macroprudential policy and interaction with monetary policy: IMF (2013 Board Paper forthcoming); Dell’Ariccia et al. (2013); Crowe et al. (2013).
- Databases and empirical sources referenced:
  - Laeven and Valencia crisis dates (2008, 2011) are used for banking, currency, and debt crises.
  - Forbes and Warnock (2011) dates for sudden stops.
  - Sample coverage noted repeatedly: 23 advanced countries covering 1960-2011; 40-country and 181-country samples appear in specific analyses.

### Figure-based Empirical Findings and Metrics
- Figure 1 — Evolution of House Prices During Financial Crises:
  - Real house price index normalized to 100 five years prior to the banking crises.
  - "Big 5" refers to the average of indices for the five major banking crises: Spain - 1977, Norway - 1987, Finland - 1991, Sweden - 1991, and Japan - 1992.
  - For the current crisis, the beginning date is assumed to be 2007Q3.
  - U.S. house price series: S&P Case-Shiller National Home Price Index.
  - Sources: BIS, OECD, and Haver Analytics.

- Figure 2.A — Credit and Asset Price Booms (sample: 23 advanced countries, covers 1960-2011):
  - Metrics reported:
    - Duration: sample mean (time to attain previous peak after trough).
    - Amplitude: sample median (one-year change after trough).
    - Slope: sample median (amplitude from peak to trough divided by duration).
  - Booms defined as top 25 percent of upturns by amplitude.
  - Statistical significance: *** indicates difference between financial boom and other upturns significant at 1 percent level.

- Figure 2.B — Credit Crunches and Asset Price Busts (sample: 23 advanced countries, covers 1960-2011):
  - Metrics reported:
    - Duration: number of quarters between peak and trough (mean).
    - Amplitude: median decline during downturn.
    - Slope: amplitude divided by duration.
  - "Crunches and busts" are the worst 25 percent of downturns by amplitude.
  - Statistical significance: ***, ** indicate significance at 1 and 5 percent levels, respectively.

- Figure 3 — Coincidence of Financial Booms and Crises (sample: 40 countries):
  - Values show percent of cases in which a crisis or poor macroeconomic performance happened after a boom (out of total number of boom cases).
  - Source: Dell’Ariccia et al. (2011).

- Figure 4 — Coincidence of Financial Crises (sample: 181 countries):
  - Crisis coincidence definition: a financial crisis starting at time T coincides with another if the latter starts between T-3 and T+3.
  - Crisis counts referenced: Banking Crises (147), Currency Crises (217), Debt Crises (67), Sudden Stops (219).
  - Dates sourced from Laeven and Valencia (2008, 2011) and Forbes and Warnock (2011).

- Figure 5 — Average Number of Financial Crises over Decades:
  - Shows average number of financial crises by decade (1970s, 1980s, 1990s, 2000s).
  - Crisis types charted: Currency Crises, Banking Crises, Debt Crises, Sudden Stops.
  - Sources: Laeven and Valencia (2008, 2011); Forbes and Warnock (2011).

- Figure 6 — Coincidence of Recessions and Crises (sample includes 23 advanced countries and 38 emerging market countries; covers 1960-2011):
  - A recession is associated with a financial crisis if the crisis starts at the same time as the recession or one year before or two years after the peak of the recession.
  - Event counts shown for: World, Advanced Countries, Emerging Market Countries; All Recessions vs. Recessions with Crises (number of events).

- Figure 7 — Real Implications of Financial Crises, Crunches, and Busts (sample: 23 advanced countries, covers 1960-2011):
  - Measures:
    - Duration (means shown).
    - Amplitude (medians shown) — decline in output from peak to trough.
    - Cumulative Loss (medians shown) — overall cost of a recession, expressed in percent (combines duration and amplitude).
  - Definitions:
    - Disruptions = worst 25% of downturns by amplitude; severe disruptions = worst 12.5%.
    - Recession association definitions: credit crunch/house price bust starting at same time or one quarter before peak; financial crisis starting same time, one year before, or two years after peak.
    - Severe financial crises defined as worst 50% by output decline.

- Figure 8 — Financial Implications of Crises, Crunches, and Busts (sample: 23 advanced countries, covers 1960-2011):
  - Panels show median change in financial variables during recessions associated with indicated financial events.
  - Variables illustrated include House Prices and Equity Prices.
  - Same definitions of disruptions, severe disruptions, and associations as Figure 7.

- Figure 9 — Creditless Recoveries (sample: 23 advanced countries, covers 1960-2011):
  - Plots median year-over-year growth rates (percent change from a year earlier) of Credit, Output, and House Prices during recessions associated with credit crunches.
  - Zero denotes the peak; x-axis is quarter relative to recession start (zero is quarter at which a recession with credit crunch begins).

### Key Methodological Notes Embedded in Figures
- Consistent sample specification: many analyses use 23 advanced countries covering 1960-2011; other analyses use 40-country or 181-country samples depending on topic.
- Definitions of events and thresholds:
  - Booms: top 25 percent of upturns by amplitude.
  - Disruptions/crunches/busts: worst 25 percent of downturns by amplitude; severe = worst 12.5 percent.
  - Crisis coincidence window: ±3 periods around crisis start.
  - Recession–crisis association window: crisis starts same time, one year before, or two years after recession peak (in specified analyses).
- Statistical reporting standards: use of sample means for durations and medians for amplitudes and cumulative losses; significance annotations (***, **) reported for group differences.

*Italic: Source material is the "_wp1328 - References" PDF content unit.*

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