Types of Economic Crisis

17 July 2010 by Tejvan Pettinger

In the past few years, we have had a bewildering array of different crisis –
credit crunch, financial crisis, fiscal crisis, banking crisis, economic crisis,
depression economics, oil price shock, currency crisis, housing crashes and
more.

Arguably, we should be calling continued mass unemployment a crisis. In

many ways, it is more serious than a currency or credit crisis.

All crisis are to some extent interrelated. Here’s a summary of what they
involve.

Types of Economic Crisis

Credit Crisis
This is a crisis primarily involved in the financial sector. It refers to the lack of
money and credit for banks and other financial institutions. For example, in
2008, many banks found it difficult to gain sufficient access to credit. They
had come to rely on borrowing money on money markets, but due to loan
default and a collapse in confidence, banks were reluctant to lend. Some
banks ran out of money completely and went bust (in case of Lehman
Brothers) or had to be rescued – Northern Rock. See: Credit crisis
Financial Crisis
This is really another name for a credit crisis. However, it implies a wider
implication. As well as difficulty in getting funds it relates to the implications
of banks and consumers not being able to borrow leading to banks suffering
from insufficient funds. Financial crisis explained
 Financial Crisis Asia 1997
 Japanese Financial Crisis
Economic Crisis
When people talk of an economic crisis, it could involve a variety of serious
economic problems such as currency collapse, hyper inflation. Perhaps the
most common crisis is a steep fall in GDP and deep recession. This is the
most serious economic crisis as it leads to the most serious impact on
human welfare – in terms of economic inactivity and mass unemployment.
The credit crisis played a direct role in leading to wider economic problems a
year later. See: Economic Crisis
Fiscal Crisis
A fiscal crisis refers to governments struggling to repay its debt and
struggling to borrow enough money to meet its budget deficit. If markets
fear governments have borrowed too much, and there is little chance of
repayments, there will be selling of the government bonds, pushing up
interest rates and giving government bonds a very low credit rating. It then
becomes a difficult cycle to break. Markets won’t lend. Governments have to
cut the deficit by slashing spending. But, slashing spending can cause a fall in
GDP and hence even lower tax revenues. A fiscal crisis usually involves
governments seeking outside help such as IMF intervention. e.g. European
Fiscal Crisis.

 An economic crisis will worsen a governments budget deficit as

tax revenues fall in a recession. Also in a financial crisis, markets
are more sensitive to risk and may worry if governments look
vulnerable. See also sovereign debt crisis
Currency Crisis
A currency crisis occurs when there is a rapid fall in the value of the currency
as investors become nervous of holding a countries assets. A gradual
depreciation (like 20% fall in the value of Sterling over the past couple of
years) would not be seen as a currency crisis. However, in the case of Iceland,
the value of the Icelandic currency fell very rapidly as people lost confidence
in the Icelandic financial sector. A currency crisis can be caused by a fiscal
crisis. If governments look to default on bonds, foreign investors will want to
sell any bonds they have causing a fall in the exchange rate. A currency crisis
can also occur in a semi-fixed exchange rate if markets feel a currency is
overvalued. e.g. Sterling in 1992 when it was in ERM. What causes currency
collapse?
Hyperinflation
When there is very high inflation and the value of money collapses making
ordinary transactions difficult. Hyperinflation
Supply Side Shock
A rapid rise in oil prices can depress an economy, leading to higher inflation
and lower output. (Shift in SRAS to the left). e.g. UK economy in 1970s

Asian Financial Crisis 1997

https://www.economicshelp.org/blog/glossary/financial-crisis-asia-1997/

The Asian financial crisis of 1997 refers to a macroeconomic shock

experienced by several Asian economies – including Thailand, Philippines,
Malaysia, South Korea and Indonesia. Typically countries experienced rapid
devaluation and capital outflows as investor confidence turned from over-
exuberance to contagious pessimism as the structural imbalances in the
economy became more apparent.

The crisis of ’97-99 followed several years of rapid economic growth, capital
inflows and build up of debt, which led to an unbalanced economy. In the
years preceding the crisis, government borrowing rose, and firms
overstretched themselves in a ‘dash for growth.’ When market sentiment
changed foreign investors sought to reduce their stake in these Asian
economies causing destabilising capital outflows, which caused rapid
devaluation and further loss of confidence.
Due to the financial instability, the IMF was requested to intervene. The IMF
implemented $40 billion of financial bailouts and also instigated economic
reforms to tackle the economic imbalances.

Unlike the debt crisis in Latin America, the debt crisis in East Asia stemmed
from inappropriate borrowing by the private sector. Due to high rates of
economic growth and a booming economy, private firms and corporations
looked to finance speculative investment projects. However, firms
overstretched themselves and a combination of factors caused a
depreciation in the exchange rate as they struggled to meet the payments.

Long-term causes of the Asian Financial Crisis

 Foreign debt-to-GDP ratios rose from 100% to 167% in the

four large ASEAN economies in 1993-96. Foreign companies were
attracting capital inflows from the developed world. Investors in
the West were seeking better rates of return, and the “Asian
 economic miracle’ seemed to offer better rates of return than
lower growth economies in the West.
 Current account deficits. Countries like Thailand, Indonesia,
South Korea had large current account deficits; this meant they
were importing more goods and services than they were
exporting – it was a reflection of very high rates of economic
growth and consumption. The current account deficits were
financed by hot money flows (on capital account). Hot money
flows were accumulated because of higher interest rates in the
East.
 Fixed or semi-fixed exchange rates. This made currencies
vulnerable to speculation. Also, interest rates were used to
maintain the value of a currency. Causing relatively high-interest
rates in S.E. Asia which caused hot money flows.
 Financial deregulation encouraged more loans and helped to
create asset bubbles. But, the regulatory framework and
structure of banking and firms meant loans were often made
without sufficient scrutiny of profitability and rates of return.
 Moral Hazard. With a strong political desire for rapid economic
growth, governments often gave implicit guarantees to private
sector projects. This was magnified by the close relationships
between large firms, banks and the government. This closeness
encouraged private firms to place less emphasis on the costs of
projects and an assumption expansion plans would be
supported by the government
 Over-exuberance. The booming economy and booming
property markets encouraged expansive borrowing by firms. It
also encouraged international investors to move the capital to
these fast-growing economies. There was an element
of irrational exuberance – the idea that Asian economies were
undergoing an economic miracle where high returns were
guaranteed.
Causes which precipitated the crisis

 Higher US interest rates. In the late 1990s, the US started to

increase interest rates to reduce US inflationary pressures.
 Higher interest rates in the US made the East less attractive as a
place to move hot money flows. As hot money flows into the East
slowed down, Asian currencies started to fall and governments
struggled to keep exchange rates at their fixed level against the
US Dollar.
 Contagion. On 2 July 1997, due to speculative attacks, Thailand
was forced to float their currency the Thai Bhat. This caused a
rapid devaluation, which triggered a loss of confidence
throughout the Asian economies. Soon, other countries were
forced to devalue as investors wanted to get out of Asian
currencies. Investors realised the previous optimism was
starting to look misplaced.
 Debt default. In the run-up to the crisis, both government and
private firms built up high external debt ratios. However, the
devaluations caused debt repayments to become more
expensive and as a result firms and countries started to default
on their debt repayments.
 At this stage, the IMF intervened to try and stabilise the crisis.
However, their intervention has proved very controversial, with
many arguing that their intervention made things worse. Higher
interest rates in Indonesia and the Philippines did not stop the
devaluation of the currency – suggesting investors were not
convinced such high-interest rates were sustainable.
 The IMF insisted on fiscal restraint – lower spending, higher taxes
and privatisation. This contractionary fiscal policy caused the
economic downturn to exacerbate and the economy plunged
into recession. Bankruptcies increased and there was a flight of
capital.
 Economists such as Joseph Stiglitz and Sachs emphasised the
importance of market sentiment in increasing the magnitude of
the problem. The initial problem was containable but because
confidence evaporated there was a flight of investors – like a
classic bank run causing an unstoppable downward momentum.
Impact of Asian Financial Crisis
Severe Recession. Hit by the loss of confidence and rise in debt repayments,
firms cut back on investment, leading to lower growth. The large
devaluations also hit consumer spending as the price of imports and
imported raw materials rose. This caused a recession in countries, such as
South Korea, Indonesia, Malaysia and Thailand. Measured in dollar terms,
Indonesia experienced a catastrophic 84% fall in GNP between June 1997 and
July 1998.
Inflation – devaluation caused import prices to rise.
Global effects. The Asian crisis hit investor confidence in the US, though
lower interest rates helped to stabilise US economy. China was largely
insulated from the crisis because China had attracted physical capital
investment and did not rely on foreign flows of capital. The crisis had a
negative effect on Japan’s economy and they struggled with a decade of low
growth.
Recovery

To a large extent, the Asian economies have recovered from the crisis. In
particular, South Korea, Malaysia and Hong Kong have enjoyed strong
economic growth.
Russian economic crisis
17 December 2014 by Tejvan Pettinger

With economic sanctions and a plummeting price of oil, the Russian economy
is seeing a real economic crisis. The value of the rouble is falling – causing
inflation and a decline in living standards. Government tax revenues are
falling as oil tax revenues decline. On top of a falling Rouble, the economy
faces recession due to declining export revenues, falling real incomes, a
collapse in confidence and higher interest rates.

Causes of Russian economic crisis

Oil dependent economy. The Russian economy has done well in recent
years from high oil and gas prices. This has led to strong export revenues
and government tax revenues. In 2012, the oil and gas sector accounted for
52% of federal tax funds and 70% of exports But, the near 50% in oil prices
have caused the economy to suffer. Unfortunately, the strength of the oil
industry has meant alternative manufacturing industries remain
undeveloped – and unable to benefit from more competitive export prices.
The Russian oil economy is an example of the Dutch disease.
Falling oil prices. The oil price has collapsed from $115 a barrel in June 2014
to just above $60 in Dec 2014. Falling oil prices have caused a big fall in
export revenue, a fall in real GDP and a fall in government tax revenues.
Economic sanctions. Sanctions imposed by the EU and US since the issues
around the Ukraine have damaged the ability of some Russian firms to raise
finance. On their own, the sanctions are quite limited in effect, but combined
with the timing, they are a big blow to confidence in the Russian economy.
Recession. Due to the 50% devaluation in the Rouble, the price of imported
goods has increased, leading to imported inflation. With inflation running at
9%, consumers are seeing a fall in real wages. Wages, pensions and benefits
are not keeping up with rising cost of living. This is causing lower spending.
The Central Bank faces a difficult dilemma – because of the recession it
needs to cut interest rates, but the falling Rouble has caused it to increase
interest rates to 17% – to try and protect the value of the Rouble – but, this
will further reduce spending and lower growth. (See: effect of higher interest
rates). With the oil and gas sector hit, big firms are likely to lay off workers,
due to the fall in demand and revenue. This rise in unemployment will
exacerbate the recession. It’s a tough combination of factors, which give the
government and Central Bank little room for manoeuvre.

Source: Independent
Falling Rouble. Despite high foreign currency reserves, the Rouble has fallen
in value, suggesting investors have lost confidence in the Russian Central
Bank, the Russian economy and the Rouble. The problem of the falling
confidence in the Rouble, is that it is encouraging capital flight – where
Russians seek to protect the value of their wealth by transferring it into
other currencies outside Russia. This is a toxic mix – a self-reinforcing cycle of
falling Rouble, causing more people to give up on the Rouble.
 Usually a fall in the value of a currency could cause a boost to
export demand and help economic growth. But, the economy
has become reliant on the oil and gas industries and so the
manufacturing export industry is quite weak and unable to
benefit
Is the crisis likely to end?

 Russia had a very large $200bn trade surplus for 2014. This
surplus is shrinking, but still it is better than the situation might
suggest.
 The boom years did allow Russia to build up more than $400bn
in foreign reserves.
 Russian manufacturing has received a boost – both from
sanctions hitting import spending, and falling Rouble making
exports cheaper. It will take time, but the crisis may help
rebalance the Russian economy. It may also help the proceeds of
economic growth to be distributed more equally. The gas and oil
dependent economy lead to the creation of many billionaires. In
2014, 110 individuals owned 35% of Russian financial wealth.
One of the highest levels of wealth inequality in the world.
 Do the West really want to see the Russian economy enter free
fall? Putin may not be liked, but the uncertainty of any alternative
may encourage them to prevent any real crisis which could
destabilise the region further.
 The fall in the Rouble suggests it is not so much economic
fundamentals as the ‘animal spirits’ of investors. If this negative
cycle can be broken, the Rouble could stabilise on the economic
fundamentals which have some positive benefits.
 The oil price has collapsed from $115 to $60, but it remains to be
seen whether this is a permanent fall; the history of oil prices
suggest it is notoriously volatile and could increase again.