, etc. however, shocks to the financial system make the adverse selection and moral hazard problems worse, and then credit tends to dry up, which is termed a “ credit crunch. ” the lack of credit leads individuals and firms to cut their spending, resulting in a contraction of economic activities. four factors exacerbate asymmetric information problems, contributing to financial instability : the deterioration of financial sector balance sheets, rise of interest rates, increases in uncertainty, and the deterioration of non - financial sector balance sheets due to changes in asset prices. this is why the government and the central bank intervene in financial markets promptly during a crisis. the central bank provides liquidity by acting as “ the lender of last resort. ” this helps the payment system work smoothly, and prevents the price of assets from dropping excessively. this, in turn, helps financial firms keep their balance sheets in better shape. the government injects public funds into banks for recapitalization and helps financial firms dispose of their non - performing assets by establishing special agents or bad banks. sometimes, the government and the central bank engage in financial markets directly by taking over banks or buying commercial papers. another important measure is enhancing transparency by disclosing key economic, financial and corporate sector information. all these measures alleviate the asymmetric information problem, helping prevent herd behavior. so far, we talked about the causes and amplification mechanisms of crises. bearing this theoretical understanding in mind, let us move on to the history of economic crises. 3. a short history of financial crises today, i would like to review four major financial crises that have taken place since 1980. these are the latin american debt crisis of the 1980s, the nordic banking crisis of the early 1990s, the asian currency crisis of the late 1990s, and the latest us financial crisis in 2007. i chose them because they are most relevant for understanding the evolution of the global economy, although the choice may be somewhat arbitrary. i leave out the crisis which took place in japan in the early 1990s and the long - term stagnation afterwards not only because i would not presume to venture in an area where your expertise is preeminent, but also it does not have great relevance to today ’ s topic. as we review each crisis, we will find common characteristics as well as its own particular features. 3. 1 latin america ’ s debt crisis of the 1980s let ’ s start by looking at the latin american debt crisis of the 1980s. in the

##ses and policy prescriptions by researchers and policymakers. however, it is also true that there are some common elements to many financial crises. understanding these common factors is critical for preventing a potential financial crisis from materializing. two key questions facing policymakers are how to reduce the risk of a financial crisis and how to cope with one when it does occur. understanding the common elements of crises is quoted from james h. stock and mark w. watson, “ how did leading indicator forecasts perform during the 2001 recession? ” ( federal reserve bank of richmond economic quarterly, vol. 89 / 3, summer 2003 ). related to the first question and can contribute to reducing the probability of financial crises even though it is not possible to escape them completely. the second question is related to identifying the amplification mechanisms behind a crisis. by doing this, we can check the spread of a crisis and contain the consequences once it has been triggered and a crisis erupts. 2. 1 causes of financial crises there are several frameworks to explain the origins or causes of financial crises in economics. even though there may be many ways to categorize them, i would like to classify them into two broad categories : the “ fundamentalist view ” and the “ human nature view. ” the first view posits a financial crisis as a rational response of economic agents to exogenous events. such external events include changes in fundamentals like the terms of trade or international financial market conditions which alter rational perceptions of agents as to future cash flows. thereby, agents change their attitude toward risk, which is reflected in leverage limits, risk pricing, and asset prices. moreover, according to this view, there is a fundamental intrinsic weakness within the financial system as douglas diamond and philip dybvig demonstrated. 2 banks provide liquidity services to the market and thus themselves take on large liquidity risks. due to this inherent weakness, there are multiple equilibria : everyone should stay in if everyone else does, but everyone should pullout if everyone else does. so, a relatively small exogenous shock can move an economy from one equilibrium to another one and sometimes provoke a devastating crisis. the second approach is based on the view that human nature is prone to irrationality. according to hyman minsky, the financial system itself has a tendency to generate economic instability through endogenous waves of euphoria and anxiety. 3 myopia and herd - like behavior rather than rational long - term calculations