FINANCIAL CRISIS
International Political Economy
Contents
1 Key terms definition
2 Theoretical perspective
3 Case study assignment
Financial crisis
A financial crisis is often associated with one or more of the
following phenomena: substantial changes in credit volume
and asset prices; severe disruptions in financial
intermediation and the supply of external financing to
various actors in the economy; large scale balance sheet
problems (of firms, households, financial intermediaries and
sovereigns); and large-scale government support (in the
form of liquidity support and recapitalization). As such,
financial crises are typically multidimensional events and
can be hard to characterize using a single indicator.
Asset price bubbles occur when the price of an asset—such as real
estate, stocks, or commodities—rises significantly above its intrinsic
value due to speculative behavior, leading to unsustainable growth.
When investors continue to buy the asset with the expectation that
prices will keep rising, demand surges, further inflating the price.
However, this growth is usually fueled by speculation rather than
fundamental economic factors like actual demand or value.
A bubble typically bursts when investors realize that the asset prices
cannot be justified by fundamentals, leading to a sudden sell-off, causing
prices to plummet.
Credit booms can be triggered by a wide range of factors, including shocks
and structural changes in markets. Shocks that can lead to credit booms
include changes in productivity, economic policies, and capital flows. Some
credit booms tend to be associated with positive productivity shocks. These
generally start during or after periods of buoyant economic growth.
Sharp increases in international financial flows can amplify credit booms.
Most national financial markets are affected by global conditions, even
more so today, making asset bubbles easily spill across borders. Rapid
expansion of credit and sharp growth in house and other asset prices were
indeed associated with large capital inflows in many countries before the
recent financial crisis.
Banking crisis
A banking crisis occurs when a significant part of the
banking sector becomes insolvent or faces liquidity
problems, often due to a large number of bad loans or bank
runs (where many depositors withdraw their money
simultaneously, fearing the bank will fail). This can cause
widespread panic, loss of confidence in the financial system,
and a credit crunch, leading to severe economic
consequences.
Currency crisis
A currency crisis happens when a country's currency rapidly
loses value in the foreign exchange markets, often due to
unsustainable fiscal policies, high inflation, or loss of
confidence by international investors. This can lead to sharp
devaluations, inflation spikes, and the need for international
bailouts.
Sudden stops
Sudden stops refer to sharp and abrupt reversals in capital inflows into an
economy, particularly emerging markets. These events occur when international
investors suddenly pull out their investments, leading to a rapid reduction in
available external financing. This often results in a financial or economic crisis for
the affected country due to the economy’s dependence on foreign capital for
growth, liquidity, and currency stability.
Loss of investor confidence due to domestic economic issues (e.g.,
unsustainable fiscal policies, inflation).
External shocks, such as a global financial crisis or rising interest rates in
developed countries (which attract capital away from emerging markets).
Political instability or a decline in governance quality in the affected country.
Foreign Debt Crisis
A foreign debt crisis occurs when a country is unable to meet its debt obligations
to foreign creditors, typically involving loans denominated in foreign currencies
(such as U.S. dollars or euros). When a country borrows extensively from
international markets or foreign governments, it takes on the risk that currency
depreciation or economic instability will make it difficult to repay those loans.
Causes of Domestic Debt Crisis:
1. Excessive Government Borrowing
2. High Interest Rates
3. Monetary Policy
Domestic Debt Crisis
A domestic debt crisis occurs when a country cannot repay debt owed to its own
citizens or institutions. Domestic debt is usually denominated in the local currency
and is often held by domestic banks, pension funds, or citizens in the form of
government bonds. While domestic debt is generally considered less risky than
foreign debt (because the government can print its own currency),
mismanagement or excessive borrowing can still lead to a crisis.
Causes of Domestic Debt Crisis:
1. Excessive Gov Borrowing
2. High Interests Rates
3. Monetary Policy
Case study assignment
