Understanding past and future financial crises

by Pierre-Olivier Gourinchas and Maurice Obstfeld

Vox
February 1, 2012

What explains the different effects of the crisis around the world? This column compares the 2007–09 crisis to earlier episodes of banking, currency, and sovereign debt distress and identifies domestic-credit booms and real currency appreciation as the most significant predictors of future crises, in both advanced and emerging economies. It argues these results could help policymakers determine the need for corrective action before crises hit.

The global financial crisis of 2007–09 brought with it the most severe global slowdown since the early 1980s (O’Rourke and Eichengreen 2010). In contrast to that earlier episode, however, the negative output effects were relatively more severe in advanced economies compared to most developing regions, and the bounce back has generally been more vigorous in the developing world.

As Figure 1 shows:

• Even by 2010 output levels in the Eurozone, Japan, UK, and US remained barely above, or even below, their 2006 levels.
• Severe aftershocks from the 2007 financial earthquake – in the form of the Eurozone’s sovereign debt crisis and banking woes – continue unabated.

Figure 1. Real GDP relative to 2006 levels

Source: IMF, September 2011 WEO database; forecasts for 2011, 2012

What explains the seemingly different effects of the crisis in different parts of the world? Answers to that question can be especially useful in predicting future crises.

In recent research (Gourinchas and Obstfeld 2012), we have tried to understand the divergent behaviour of mature and emerging economies by comparing the 2007–09 crisis to earlier episodes of banking, currency, and sovereign debt distress throughout the world. Drawing on earlier chronologies, and adding a bit of our own judgement and primary research, we develop a database of the various types of financial crisis events that occurred between 1973 and the early 2000s.2 We then rely on an event-study methodology to inspect the antecedents and aftermaths of crises, focusing our analysis on a limited set of variables that earlier researchers have identified as important empirical or theoretical indicators of impending financial stress.

Our primary goal is to see if there are commonalities in the prologues to past crises as between advanced and emerging countries, and if the relative fortunes of different global regions differed in the recent recession because of significantly different policy choices or financial-market developments. In turn, such information could aid in predicting future crises.

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