Download Modeling Financial Crises: A Schematic Approach

Modeling Financial Crises: A
Schematic Approach
John T. Harvey
Professor of Economics
Texas Christian University
Book Idea:
A Post Keynesian Analysis of
Exchange Rates in the PostBretton Woods Era
Revised Book Idea:
Currencies and Capital Flows:
A Post Keynesian Analysis of
Exchange Rate Determination
Currencies, Capital Flows,
and Crises: 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
Where we are headed…
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
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
currency price currency
exchange rate
depreciation
capital flight
inflation, FX loan
default, fall in aggregate
expenditures
fixed
currency price currency
exchange rate
devaluation
capital flight
inflation, FX loan
default, fall in aggregate
expenditures
Crisis type
2. An overlooked factor
The Investment-Capital Cycle
3. Seeing Everything at Once
Minsky Crisis
Asset-Market Crisis
Currency-Market Crisis
Complete Model
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.