The global financial crisis of 2008-2009 was the worst economic calamity since the Great Depression. The crisis was an extremely complex event the causes of which are still disputed among economic scholars. Academic accounts of the economic disaster are characterized by disparate interpretations and a high level of heterogeneity (Lo, 2012). This paper attempts to reconcile opposite narratives of the event in order to outline reliable predictors of an economic and financial crisis. It will also describe regulatory responses to the global financial crisis and explicate the current state of crisis management.
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Before starting the discussion of predictors of a financial crisis, it is necessary to understand the causes of the crisis of 2008-2009. The most commonly indicated reason for the crisis is a rapid financial expansion, which was triggered by the deterioration of lending standards (Claessens & Kodres, 2014). Another cause of the crisis is asset price appreciation that exceeded 30 percent in the US (Zestos, 2015). The creation of new financial instruments is also often mentioned as a cause of the crisis. The fourth frequently invoked reason for the calamity is financial deregulation (Zestos, 2015).
When it comes to predicting economic and financial crises, both qualitative and quantitative frameworks can be used. The following five areas can be examined from the qualitative point of view in order to avoid future economic disasters: “reflexive dynamics, excessive leverage, overconfidence, policy distortions, and herd-like behavior” (Martinez, 2016, p. 10).
The first area refers to the fluctuations in demand during boom and bust cycles. The second area focuses on the creation of new financial instruments. Overconfidence manifests in excessive spending and optimistic assessment of economic prospects, which skews the process of decision-making and results in unnecessary risk-taking (Erkens, Hung, & Matos, 2012; Ho, Huang, Lin, & Yen, 2016). Another area is the distortion of the buyer-seller interaction process through the introduction of new policies and regulations. The fifth area concentrates on social influence in economic decision-making (Martinez, 2016).
Quantitative indicators of a crisis include but are not limited to the credit-to-GDP ratio, valuation pressures, financial sector imbalances, and quality of debt burden. The findings of a study conducted by Hindmoor and McConnell (2013) show that the global financial crisis could have been avoided if policymakers paid heed to “the level of international reserves and real exchange rate overvaluation” (p. 548). Also, the Federal Reserve has issued a heat map that contains 44 statistically significant indicators of an upcoming financial crisis (Martinez, 2016).
Achievements and Pending Issues
The global financial crisis was caused by the dissemination of financial risks through a large number of transmission channels; therefore, there is a need for global macroeconomic policy regulation. To this end, the G20 created the Financial Stability Board (FSB) in 2009 (Dakic, 2014). The body’s main focus is the identification of fiscal policy vulnerabilities. It also exists for the promotion of information exchange between different financial institutions, monitoring of financial practices, and setting guidelines for “the contingency planning for cross-border crisis management” (Dakic, 2014, p. 14).
The main achievement in dealing with the consequences of the global financial crisis and introducing precautionary arrangements is the establishment of a global financial stability framework. The framework has appeared as the result of cooperation between the following organizations: the Committee on the Global Financial System (CGFC), the International Monetary Fund (IMF), and the Committee on Payment and Settlement Systems (CPSS) (Dakic, 2014). The European Union (EU) has responded to the crisis by establishing several bodies responsible for macroprudential and macroprudential supervision and regulation.
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In order to rectify the damage caused by the crisis, G20 countries have managed to close key information gaps and adopt new policies aimed at the elimination of incentives for risk-taking. Other reforms to date include the development of liquidity standards and more intense supervision of ‘too-big-to-fail’ institutions (Claessens & Kodres, 2014). The IMF also has stepped up its efforts to strengthen global financial and economic stability and introduced a set of far-reaching governance reforms (IMF, 2016). Moreover, the body has revamped its lending tools and terms in an attempt to reduce the contagiousness of future crises. Most importantly, the IMF has strengthened its financial surveillance strategy and sharpened its policy advice (IMF, 2016).
Despite major achievements in the area of economic and financial stability, some pending issues remain. Namely, new policies have failed to deal with the problem of public debt overhang (Reinhart & Rogoff, 2015). Also, artificially low-interest rates still incentivize banks to take unnecessary risks (Elliott, 2017).
The Risk of a New Crisis
Even though it is impossible to predict the date of the next global financial meltdown, some of its signs can be recognized. The last global financial stability report issued by IMF shows that numerous “medium-term risks continue to build” (Coy, 2016, para. 2). The report also indicates low-interest rates and low global growth as risk factors of a pending crisis. Taking into consideration the underlying debt issue, it can be argued that global authorities might not be able to prevent the emergence of a new crisis.
The paper has outlined indicators of economic and financial crises and discussed global policy and regulatory responses to the global financial crisis of 2008-2009. It has been argued that despite significant progress in mitigating economic and financial risks, the world is still in danger of a financial turmoil.
Claessens, S., & Kodres, L. (2014). The regulatory responses to the global financial crisis: Some uncomfortable questions.
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Elliott, L. (2017). Low interest rates put global financial sector at risk, IMF warns. The Guardian.
Erkens, D., Hung, M., & Matos, P. (2012). Corporate governance in the 2007-2008 financial crisis: Evidence from financial institutions worldwide. Journal of Corporate Finance, 18(1), 389-411.
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Zestos, G. (2015). The global financial crisis: From US subprime mortgages to European sovereign debt. Abington, England: Routledge.