Term

Sequence of a Financial Crisis

Definition

1. Initial Phase 2. Banking Crisis 3. Debt Deflation

Term

What are ways a financial crisis can begin? (Initial Phase)

Definition

1) Credit Boom and Bust 2) Asset-Proce Boom and Bust 3) Increase in Uncertainty

Term

Credit Boom and Bust

Definition

• Mismanagement of financial innovation can lead to elimination of restrictions, new financial products • Both can lead to a credit boom - Government safety nets weaken incentives for risk management - Depositors ignore bank risk-taking • Loan losses accrue and eventually asset values fall, leading to a reduction in capital • Financial institutions cut back lending (called deleveraging), and bank funding falls as well • As institutions cut back on lending, financial system loses primary solution to information asymmetry • Economic spending contracts as loans become scarce