Modeling Financial Crises: A Schematic Approach

1. Modeling Financial Crises: A Schematic Approach John T. Harvey Professor of Economics Texas Christian University

2. Book Idea:A Post Keynesian Analysis of Exchange Rates in the Post-Bretton Woods Era

4. Revised Book Idea:Currencies and Capital Flows:A Post Keynesian Analysis of Exchange Rate Determination

6. Currencies, Capital Flows,and Crises: A Post Keynesian Analysis of Exchange Rate Determination

8. Mexican Financial Crisis: 1994 Asian Financial Crisis: 1997 Minsky crises (debt default) Currency crises (catastrophic depreciation/devaluation) Asset-market crises (catastrophic depreciation)

9. 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

10. Where we are headed…

11. 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

12. Types of Crises

13. 2. An overlooked factor The Investment-Capital Cycle

14. 3. Seeing Everything at Once

15. Minsky Crisis

16. Asset-Market Crisis

17. Currency-Market Crisis

18. Complete Model

19. 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.