Modeling Financial Crises: A Schematic Approach
John T. Harvey
Professor of Economics
Texas Christian University
Revised Book Idea:
Currencies and Capital Flows: A Post Keynesian Analysis of Exchange Rate Determination
Mexican Financial Crisis: 1994
Asian Financial Crisis: 1997
•Minsky crises (debt default)
•Currency crises (catastrophic depreciation/devaluation)
•Asset-market crises (catastrophic depreciation)
Goals of Paper
1. Show that all financial crises are manifestations of the same phenomenon
2. Highlight an often overlooked factor
3. Model the economy in a way that allows us to see “everything” at once
4. Compare the model to various historical incidents
1. All financial crises are manifestations of the same
phenomenon
the development of increasingly optimistic forecasts alongside
economic forces that cannot justify those expectations
Stages of Crisis:shock => negative repercussions => contagion
Types of Crises
Crisis type
focus of expectations
negative repercussion
initial contagion secondary effects
Minsky manageable debt load
default chain default credit crunch
asset market asset price collapse in asset price
downward revision of related price forecasts
fall in expectation of profit from investment, fall in aggregate expenditures, fall in mpc
flexible exchange rate
currency price currency depreciation
capital flight inflation, FX loan default, fall in aggregate expenditures
fixed exchange rate
currency price currency devaluation
capital flight inflation, FX loan default, fall in aggregate expenditures
Conclusions
The root cause of financial crisis is the initially gradual and eventually rapid separation of expected returns from what the real economy can actually generate. Ultimately, evidence of the relative under performance of the nonfinancial sector will become known. Shock, negative repercussions, and contagion result. Depending on the magnitude, the economic impact can be significant and even catastrophic. This phenomenon is, given the current structure of market economies throughout the world, systemic. It does not require “crony capitalism,” unique events, or government “interference” with the market mechanism–it is, in fact, the market mechanism itself that causes this outcome.