Such is not the case elsewhere. In fact, one way we have gained a greater appreciation for the importance of the financial system is by comparing economic performance across countries with different financial systems. Over the past several years, there is increasing evidence, drawn from the experience of newly emerging market economies in Eastern Europe, Asia, and Latin America, that financial structure is a key feature distinguishing relative economic performance. Countries with a fragile financial system, a weak legal and regulatory structure, and state ownership or control of financial institutions are generally more prone to crises and show weaker economic performance. The second way that we have come to appreciate the role of financial institutions is in times of financial stress when the intermediation process no longer functions effectively and when falling asset prices undermine household and firm balance sheets.
Financial crises can affect the economy in a number of ways.
Borrowers experiencing a sudden increase in the cost or a reduction in the availability of credit may be forced to curtail their spending, resulting in a contraction in output and employment. In addition, changes in asset prices may generate changes in wealth that affect spending directly as well as influencing consumer and business confidence. Over the past recent decades, we have seen an increased incidence of financial crises around the world. Indeed, in just the past twenty years, more than two-thirds of IMF member countries have experienced one or more financial crises. Many of these crises have had severe economic consequences in terms of lost output and employment.