Chapter 3 – Financial Crisis

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 Endogenous vs Exogenous theory

Exogenous risk arrives to the financial system like an asteroid might hit earth
– it comes as a surprise, there is nothing we do to precipitate its arrival, and it
can cause enormous damage. To the financial system, the coronavirus shock
is purely exogenous. (Jon Danielsson, Robert Macrae, Dimitri Vayanos, Jean-
Pierre Zigrand 26 March 2020).

- Equilibrium Model of the business Cycle (Lucas)

- Real Business Cycle theory
- Plucking Model (Friedman)

Endogenous risk arrives within the financial system and is created by people
interacting with each other.

- Austrian Business Cycle theory

- Minsky moment

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 Equilibrium Model of the business cycle (Lucas)

 The economy is considered as different markets in a situation of equilibrium.

 Due to the existence of imperfect expectation, an accommodative monetary

policy would lead to a boom leading to inflation and a subsequent recession.

 This theory consider that economic agents do not identify the fact that the boom
stage is coming from monetary reasons. They therefore increase their investment
before they realise that there is no specific demand.

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 Real Business Cycle Theory

 Similar idea than before with the main difference being that the exogenous shock
may come from a change in technology for example, a loss of productivity (which
could come from a health crisis etc).

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 Austrian Business Cycle Theory

 The idea is that a punctual monetary policy by lowering short term interest rate
artificially will provide the signal to entrepreneurs to invest.

 Those investments will be revealed as a cluster of entrepreneurial errors coming.

 The boom (coming from more investment) effect will be followed by a burst as
entrepreneurs will have to give up their investments.

 The monetary policy is responsible for the business cycles as it interferes with
entrepreneurs decisions to invest.

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 Minsky Moment

 Minsky Moment refers to the onset of a market collapse brought on by the

reckless speculative activity that defines an unsustainable bullish period.

 Minsky Moment crises generally occur because investors, engaging in

excessively aggressive speculation, take on additional credit risk during bull
markets.

 Minsky Moment defines the tipping point when speculative activity reaches an
extreme that is unsustainable, leading to rapid price deflation and unpreventable
market collapse.

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