Financial Crises: Explanations, Types, and Implications; by Stijn Claessens and M. Ayhan Kose; imf working Paper 13/28; January 1, 2013

 

II.   E

XPLAINING 

F

INANCIAL 

C

RISES

 

 

While financial crises have common elements, they do come in many forms. 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 

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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.  

The literature has clarified some of the factors driving crises, but it remains a challenge to 

definitively identify their deeper causes. Many theories have been developed over the years 

regarding the underlying causes of crises. While fundamental factors—macroeconomic 

imbalances, internal or external shocks—are often observed, many questions remain on the 

exact causes of crises. Financial crises sometimes appear to be driven by “irrational” factors. 

These include sudden runs on banks, contagion and spillovers among financial markets, 

limits to arbitrage during times of stress, emergence of asset busts, credit crunches, and fire-

sales, and other aspects related to financial turmoil. Indeed, the idea of “animal spirits” (as a 

source of financial market movements) has long occupied a significant space in the literature 

attempting to explain crises (Keynes, 1930; Minsky, 1975; Kindleberger, 1978).

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Financial crises are often preceded by asset and credit booms that eventually turn into busts. 

Many theories focusing on the sources of crises have recognized the importance of booms in 

asset and credit markets. However, explaining why asset price bubbles or credit booms are 

allowed to continue and eventually become unsustainable and turn into busts or crunches has 

been challenging. This naturally requires answering why neither financial market participants 

nor policy makers foresee the risks and attempt to slow down the expansion of credit and 

increase in asset prices.  

 

The dynamics of macroeconomic and financial variables around crises have been extensively 

studied. Empirical studies have documented the various phases of financial crises, from 

initial, small-scale financial disruptions to large-scale national, regional, or even global 

crises. They have also described how, in the aftermath of financial crises, asset prices and 

credit growth can remain depressed for a long time and how crises can have long-lasting 

consequences for the real economy. Given their central roles, we next briefly discuss 

developments in asset and credit markets around financial crises.