Question

In no less than 500 words, explain what is the typical pattern for a financial crisis?

Answer 1

The events associated with a typical pattern for a financial crisis happen frequently and converge together to create extreme markets such as booms,bubbles,panics,crashes and meltdown.The pattern of events that follow the crisis is as follows-

New Discovery-Economic Expansion-Increased prodution,wealth-Lower interest rates,Increased Credit-Asset Bubble-Market Correction or Crash

First,economic expansion happens due to emergence of new technology,changes in political factors,and innovation leads to discovery of new products.This results in increase in production,markets,wealth,consumption and investment which increases the credit at lower interest rates which builds up indebtness,or leverage.People tend to find new ways to invest the wealth which leads to an asset bubble and prices of some assets such as bonds,stocks,real estate or commodities such as gold,oil are very much benefitted from this expansion.The bubble continues until some event such as bank failure to collect the credit,large reversals in the current account,deep recessions and collapse of real estate prices results in building up a large share of non performing assets or bad debts,which trigger a financial crisis.

The banking crisis is at the center of financial crisis as they are bailed out and bank runs happen and the non performing assets are absorbed by the public sector by nationalizing banks and market purchase which increases the public debt to output ratio.This results in triggering sovereign debt crisis followed by debt restructuring.The government has to pay higher taxes on the bonds and take corrective actions such as printing more money and cutting spending by defaulting on their existing bonds.This impacts the expectations of the foreign and domestic investors which results in currency crisis and devaluation of the country's currency.