Financial Crises Occur – The Economy go into a Recession or Depression

Financial crisis is applied broadly to a variety of situations in which some financial assets suddenly lose a large part of their nominal value.  In the nineteenth and early twenty centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults.  Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy.  Any event that is, or is expected to lead to, an unstable and dangerous situation affecting an individual, group, community, or whole society.  Many economists have offered theories about how financial crises develop and how they could be prevented.  There is no consensus, however, and financial crises continue to occur from time to time.

Banking crisis affect the economy, When a bank suffers a sudden rush of withdrawals by depositors, it is calling a bank run.  Since banks lend out most of the cash they receive in deposits, it is difficult for them to quickly pay back all deposits, if these are suddenly demanded, so a run renders the bank insolvent, causing customers to lose their deposits, to the extent that they are not covered by deposit insurance.  An event in which bank runs are widespread is called a systemic banking crisis or banking panic.  Banking crises generally occur after periods of risky lending and resulting loan defaults.

Currency crisis also affect the economy, There is no widely accepted definition of a currency crisis, which is normally considered as part of a financial crisis.  Define currency crises as when a weighted average of monthly percentage depreciation in the exchange rate and monthly percentage declines in exchange reserves exceeds its mean by more than three standard deviations.Currency crisis as a nominal depreciation of a currency of at least 25% but it is also defined at least 10% increase in the rate of depreciation.  In general, a currency crisis can be defined as a situation when the participants in an exchange market come to recognize that a pegged exchange rate is about to fail, causing speculation against the peg that hastens the failure and forces a devaluation or appreciation.

Stock market crash and Bubble affects economy.  A speculative bubble exists in the event of large, sustained overpricing of some class of assets.  One factor that frequently contributes to a bubble is the presence of buyers who purchase an asset based solely on the expectation that they can later resell it at a higher price, rather than calculating the income it will generate in the future.  If there is a bubble, there is also a risk of a crash in asset prices, market participants will go on buying only as long as they expect others to buy, and when many decide to sell the price will fall.  However, it is difficult to predict whether an asset’s price actually equals its fundamental value, so it is hard to detect bubbles reliably.  Some economists insist that bubbles never or almost never occur.  Well-known examples of bubbles and crashes in stock prices and other asset prices, the crash of the dot- com bubble in 2000–2001, and the now-deflating United States housing bubble.  The 2000’s sparked a real estate bubble where housing prices were increasing significantly as an asset good.

International financial crisis affect currency crisis ,When a country that maintains a fixed exchange rate is suddenly forced to devalue its currency due to accruing an unsustainable current account deficit, this is called a currency crisis or balance of payments crisis.  When a country fails to pay back its sovereign debt, this is called a sovereign default. While devaluation and default could both be voluntary decisions of the government, they are often perceived to be the involuntary results of a change in investor sentiment that leads to a sudden stop in capital inflows or a sudden increase in capital flight.  Wider economic crisis makes economic recession and depression, negative GDP growth lasting two or more quarters is called a recession.  An especially prolonged or severe recession may be called a depression, while a long period of slow but not necessarily negative growth is sometimes called economic stagnation.  Some economists argue that many recessions have been caused in large part by financial crises.  One important example is the Great Depression, which was preceded in many countries by bank runs and stock market crashes.  The sub prime mortgage crisis and the bursting of other real estate bubbles around the world also led to recession in the U.S. Some economists argue that financial crises are caused by recessions instead of the other way around, and that even where a financial crisis is the initial shock that sets off a recession, other factors may be more important in prolonging the recession.

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