Economic Crises: Past, Present and Future

I. INTRODUCTION The current financial crisis that originated in the United States of America has become a catalyst for global crises. What began as the bursting of a housing bubble in the United States, resulted in a major international financial crisis. How does this current period of economic chaos compare to the financial crises of the past? By examining the major financial crises, the paper indicates commonalities among them. Based on this analysis, one may answer the question as to whether the financial regulations proposed by the United States and other countries are appropriate for the current financial crisis. The paper is organized as follows. Section II provides a literature review. Section III discusses the early United States banking panics in the 19th century. Section IV explores the crises of the 20th century and compares them to those of the previous century. Section V explains the causes and effects of the current financial crisis and compares them to previous financial crises. Section VI concludes. II. LITERATURE REVIEW The recent recession has stimulated renewed interest in the causes and effects of financial crises. Many papers theorize various causes in hopes of finding a common pattern. Bordo (2003) examines booms and busts in the United Kingdom and the United States. He concludes that recessions originated in stock market crashes deepened only if there was already financial instability. This conclusion is supported by the recessions prior to World War II in the United States, where recessions often involved both banking panics and financial distress. Reinhart and Rogoff (2008, 2009A, 2009B) present evidence that these crises are not limited to the U.S. They claim that any parallels drawn between crises in the United States can be applied to other countries. Thus, the analysis of this paper, although dealing mainly with crises in the United States, is applicable to other countries. Klomp (2010) employs 132 banking crises across 110 countries since 1970 by use of a random coefficient model. He concludes that credit growth, the Gross Domestic Product (GDP) growth rate, and the real interest rate are on average the most important indicators of a banking crisis. Yet, none of these variables is significant in more than 60 percent of the crises. Klomp thus concludes that there is no common factor in causing crises. Garcia-Herrero and Del Rio (2003) use a sample of seventy-nine countries between 1970 and 1999. They find that when the objective of the central bank is price stability, the likelihood of a banking crisis is reduced. Cihak (2007), utilizing a dynamic-panel model for the years 1985 until 2005, shows that the more independent the central bank is, the more stable its financial institutions are. Thus, the less politically constrained the Central Bank of a country is, the faster and more appropriate its actions are in preventing financial distresses. Demirguc-Kunt and Detragiache (1998) and Laeven and Valencia (2008) identify crises by determining if one of several situations occurs. These situations include the ratio of non-performing assets to total assets in the banking system exceeding ten percent, whether the cost of a government rescue operation is at least two percent of GDP, if the banking sector problems result in a nationalization of banks, or a large bank run takes place. Kaminsky and Reinhart (1999) conclude that crises are typically preceded by a multitude of weak and/or deteriorating economic fundamentals. It is rare for speculative attacks to cause a crisis when economic fundamentals are robust. They conclude that banking crises often precede balance-of-payment misalignments, not necessarily exchange rate speculation. Moreover, the evidence indicates that financial crises are significantly more severe when simultaneous banking and currency runs occur. Boyd, Nicolo, and Loukoianova (2009) question whether a "banking crisis" is actually a crisis in the banking system or just a response to government interventionist policies. …