The labour market effects of financial crises

This paper examines how the 2008–2009 financial crisis affected labour markets in Europe, and how this impact depended on employment protection laws. Using a difference‐in‐differences approach, our estimates isolate the effect of the lack of credit on the labour market from that of the general decline in aggregate economic activity. We find large and negative impacts of the credit shock on total employment, particularly on temporary, unskilled and young workers. These impacts were significantly larger in countries with stronger legal protection of permanent workers from dismissal. This suggests that the differential impact of the crisis across countries was not entirely driven by the heterogeneity of the credit shock, but also by labour regulations. Given regulatory inflexibility in adjusting the permanent workforce, firms responded to tightening financial constraints by disproportionately laying off temporary workers (who tend to be younger and less skilled than permanent workers).     

Financial frictions and total factor productivity: Accounting for the real effects of financial crises

Financial crises in emerging economies are accompanied by a large fall in total factor productivity. We explore the role of financial frictions in exacerbating the misallocation of resources and explaining this drop in TFP. We build a two-sector model of a small open economy with a working capital constraint on the purchase of intermediate goods. The model is calibrated to Mexico before the 1995 crisis and subjected to an unexpected shock to interest rates. The financial friction generates an endogenous fall in TFP and output and can explain more than half of the fall in TFP and 74 percent of the fall in GDP per worker.     

Transmission channels of international financial crises to African stock markets: the case of the euro sovereign debt crisis

This article investigates the effects of the European sovereign debt crisis on African stock markets within a Bayesian shrinkage VAR framework. This method allows us to consider both North African and Sub-Saharan African stock markets, and provides a flexible parsimonious specification. The results reveal varying reactions of the impulse response functions. The most exposed African stock markets are those of Egypt, South Africa and Mauritius, while the least affected stock market is, surprisingly, that of Ivory Coast. Our analysis shows that, in addition to direct transmission, several macroeconomic and market channels, such as commodities, exports, and exchange rates, are relevant. Specifically, countries with strong commercial links to European countries will be most impacted by the crisis. The severity of transmission also depends on the country’s dependence on commodities.     

Stability periods between financial crises: The role of macroeconomic fundamentals and crises management policies

This study aims to identify which factors explain why some countries enjoy long durations of stability, while others experience crises in shorter intervals. We analyze the duration of stability periods between currency, debt, and banking crises by employing an innovative econometric strategy, the Finite Mixture Model (FMM). Real and financial variables show high predictive power for stability spells between currency crises. Regarding debt crises, the real interest rate is observed to be the best predictor. The time between systemic financial crises appears to be prolonged through government interventions and through IMF program participation, while bank recapitalization has a negative impact.     

Systemic financial crises and the housing market cycle

Using quarterly data for a group of 20 industrialized countries and both continuous- and discrete-time duration models, we show that financial crisis recessions are associated with a two- to three-fold increase in the likelihood of the end of a housing boom. Additionally, recessions preceded by booms in mortgage credit are especially damaging, as their occurrence coincides with an increase in the duration of housing market slumps of almost 90%.     

A firm-level chronicle of financial crises in the Southern Cone

This paper chronicles the recent emergence of financial crises in the ‘Southern Cone’ countries of South America. Relying on firm-level panel data, major changes in the macro and regulatory environments are linked to changes in firms' earnings streams and financial structures. For each country, a ‘boom’ phase, a ‘squeeze’ phase, and a ‘bust’ phase are identified. It is argued that the proximate cause of this pattern was wild fluctuation in the expected real return on financial assets. Though no formal model is developed, it is suggested that these swings were due to the system of incentives created by rapid banking sector deregulation cum exchange-rate-based stabilization policies.     

The rationality of irrationality in times of financial crises

Whilst there are many models discussing the mechanics of financial crises, the notion of predation seems to be insufficiently taken into consideration as one of the explanatory behavioral factors, although it would enrich the understanding of dysfunctional financial markets. This paper provides a stylized model for disruptive and toxic economic behaviors in the context of predatory markets like the subprime crisis of 2007–2009. In this context, we investigate why consumers and sellers buy products they know to be toxic. Conventional economic models contain classical tenets that assume that consumers are rational and search for utility maximization; however, these models cannot straightforwardly explain the behaviors consumers and sellers adopted during times of financial crises, known as “exuberantly irrational”. Hence, we use and expand on a predator-prey perspective that endeavors to capture such behaviors more effectively while showing that four market variables must be considered together over time – consumers, suppliers, toxic products and regulations. Our analysis shows that during the GFC, consumers and lenders as well as regulators embraced whole-heartedly, and contrary to common economic sense, the development and marketing of toxic products. Their behaviors were actually quite rational in the context of a poisoned market. Such observation could assist in drafting regulations.     

International aid and financial crises in donor countries

The recent global financial crisis placed new economic and fiscal pressures on donor countries that may have long-term effects on their ability and willingness to provide aid. Not only did donor-country incomes fall, but the cause of the drop — the banking and financial-sector crisis — may exacerbate the long-term effect on aid flows. This paper estimates how donor-country banking crises have affected aid flows in the past, using panel data from 24 donor countries between 1977 and 2010. We find that banking crises in donor countries are associated with a substantial additional fall in aid flows, beyond any income-related effects, at least in part because of the high fiscal costs of crisis and the debt hangover in the post-crisis periods. Aid flows from crisis-affected countries are estimated to fall by 28% or more (relative to the counterfactual) and to bottom out only about a decade after the banking crisis hits. In addition, our results confirm that donor-country incomes are robustly related to per-capita aid flows, with an elasticity of about 3. Findings are robust to estimation using either static or dynamic panel data methods to account for possible biases. Because many donor countries, which together provide two-thirds of aid, were hit hard by the global recession, this historical evidence indicates that aggregate aid could fall by a significant amount (again, relative to counterfactual) in the coming years. We also explore how crises affect different types of aid, such as social-sector and humanitarian aid, as well as whether strategic interaction among donors is likely to deepen or mitigate the fall in aid.     

The real effect of financial crises in the European transition economies1

The aim of this work is to assess the impact of financial crises on output for 11 European transition economies (CEECs). The results suggest that financial crises have a significant and permanent effect, lowering long‐term output by about 12–17 percent. The effect is larger in smaller countries in which the banking sector presented more important financial disequilibria. We also found that fiscal policy has been the most efficient tool in dealing with the crises, whereas the effect of monetary policy has been rather modest. Flexible exchange rates are found to attenuate the impact of the crises in the short and medium term, but to amplify the effect in the long run. International Monetary Fund support is found to moderate the effect in the long run. Finally, the effect in the CEECs is considerably larger than in the EU advanced economies.     

Private sector involvement in the resolution of financial crises: How do markets react?

To correct the disincentives of liquidity assistance during financial crises, the official sector attempts to involve the private sector in the resolution of debt crises. This paper empirically tests the reaction of investors to announcements of private sector involvement (PSI). For this purpose, we disentangle shifts in risk premia incorporated in excess returns on emerging market bonds into changes in risk and shifts in the price of risk. A regime-switching ARCH-M model is employed to separate two regimes with respect to the market price of risk. While PSI has no effect on risk, it is shown that the likelihood of switching to a state with a high price of risk rises in response to PSI announcements. Thus, the results indicate that burden sharing was credible and, hence, effective.     

Maturity mismatch and financial crises: Evidence from emerging market corporations

Substantial attention has been paid in recent years to the risk of maturity mismatch in emerging markets. Although this risk is microeconomic in nature, the evidence advanced thus far has taken the form of macro correlations. We evaluate this mechanism empirically at the micro level by using a database of over 3000 publicly listed firms from fifteen emerging markets. We measure the risk of maturity mismatch by estimating, at the firm level, the effect on investment of the interaction of short-term exposure and aggregate capital flight. This effect is (statistically) zero, contrary to the prediction of the maturity-mismatch hypothesis. This conclusion is robust to using a variety of different estimators, alternative measures of capital flows, and controls for devaluation effects and access to international capital. We do find evidence that short-term-exposed firms pay higher financing costs, and have lower equity valuations, but not that this reduction in net worth translates into a drop in investment or sales.     

A cautious note on the use of panel models to predict financial crises

Panel data framework has often been used to build Early Warning Systems for financial crises. This paper questions the implicit assumption that crises are homogenously caused by identical factors. It suggests a preliminary step aiming at forming optimal country clusters.     

The impact of financial crises and tolerance for uncertainty

Financial crises can have severe negative effects on investment. One reason for this is that financial crises increase uncertainty, increasing the real option value of delaying investment. In this paper, we show that the negative effect of crises on investment differs significantly across countries: in countries with low tolerance for uncertainty, the negative effect is strong. The negative effect is absent in countries that are more tolerant of uncertainty. These findings are similar across different types of financial crisis; they vary as predicted across type of investor, asset and industry; and they are not driven by uncertainty-averse countries adopting more rigid institutions.     

Wealth effects on money demand in the euro area

We investigate the determinants of money demand (M3) in the euro area, considering that this variable remains an important co-determinant of monetary policy making by the European Central Bank. Regressing the real stock of M3 on real GDP, interest rates and wealth variables (real housing and stock prices) within an error-correction framework provides evidence of positive wealth effects on money demand in the long run. Correcting for this wealth effect, money demand in the euro area has grown almost exactly in line with the official reference value of 4 1/2% per annum. This article builds on research that was conducted in preparation of the annual OECD Economic Survey of the euro area and reported in Boone et al. (2004). The authors thank their colleagues in the Economics Department and the European Central Bank and two anonymous referees for their valuable comments. The authors assume full responsibility for any remaining errors and omissions. The opinions expressed in this article do not necessarily represent those of the OECD or its member countries     

Evaluating currency crises: the case of the European monetary system

In this paper we examine the nature of currency crises. We ascertain whether the currency crises of the European Monetary System (EMS) were based either on fundamentals, or on self-fulfilling market expectations driven by extrinsic uncertainty. In particular, we extend previous work of Jeanne and Masson (J Int Econ 50:327–350, 2000) regarding the evaluation of currency crisis. We contribute to the existing literature proposing the use of Markov regime-switching with time-varying transition probability model. Our empirical results suggest that the currency crises of the EMS were not due only to market expectations driven by external uncertainty, or ‘sunspots’, but also to fundamental variables that help to explain the behavior of market expectations. We would like to thank Joseph Byrne, James Mitchell, Martin Weale and two anonymous referees for very useful comments and suggestions.     

Reserve accumulation and financial crises: From individual protection to systemic risk

This paper provides a new perspective on the relationship between countries׳ international reserve holdings and financial crises: while the “local” view holds that reserves may prevent domestic crises, it overlooks that the accumulation of reserves relaxes the financing constraint of the reserve currency country and may cause a financial crisis in the centre, which is transmitted globally. According to this “global” view reserve accumulation might destabilize the international financial system. Since the crisis affects all countries alike, the accumulation of reserves imposes a negative externality on non-accumulating countries.We integrate this idea in a theoretical model of the optimal amount of reserves and illustrate the gap between local and global optimality: the consideration of systemic risk lowers the demand for reserves. Moreover, if a supranational authority determines the optimal level of reserves, it internalizes the negative externality and accumulates fewer reserves. A macroprudential tax on reserve hoardings might implement the socially optimal solution. Our calibration analysis shows that these considerations are economically significant: they lower the optimal amount of reserves in the benchmark case by 45%.     

The short- and long-run impacts of financial crises on youth unemployment in OECD countries

The impact of financial crises on the youth unemployment rate (YUR), compared to the total unemployment rate (UR), is estimated for a panel of OECD countries over the period 1981–2009, using bias-corrected dynamic panel data estimators of short- and long-run coefficients. Both YUR and UR are found highly persistent. Also, short- and long-run effects of financial crises on YUR are significantly large, respectively, some 1.9 and 1.5–1.7 times higher than the short- and long-run effects on UR. Similar results are found for the unemployment impacts of GDP growth lagged 1 year and institutional variables. These results are robust to various dynamic specifications.     

The financial accelerator and the real economy: A small macroeconometric model for Norway with financial frictions

This paper studies the salient features of a core macro econometric model that allows for self-reinforcing co-movements between credit, asset prices and real economic activity. In contrast to the economic literature that cultivates highly stylized model representations aimed at illustrating the workings and the implications of such a feature, the model of this paper integrates two mutually reinforcing financial accelerator mechanisms within the framework of a fully-fledged core macroeconomic model. The impulse responses of such a model is in line with the ones typical of SVAR/DSGE models, though the amplitude of shocks is in most cases stronger than the ones pertaining to these kinds of models. This is due to the workings of the financial accelerators that contribute to magnify the effects of shocks to the economy. A forecast comparison undertaken between our model and an alternative macro econometric model without a financial block, suggests that financial feedback mechanisms may be forecast improving.     

PPP in the medium run: The case of Norway

Existing studies generally reject purchasing power parity (PPP) on data sets from countries that have been affected by large real shocks, including Norway. However, we offer strong evidence of PPP between Norway and its trading partners during the post-Bretton Woods period, in which the Norwegian economy has experienced numerous real shocks such as discoveries of large petroleum reserves and oil price shocks. In particular, the behavior of the Norwegian real and nominal exchange rates appears remarkably consistent with the PPP theory. Moreover, convergence towards PPP is relatively rapid; the half-life of a deviation from parity is just about 1.5 years. We show that such deviations are primarily eliminated by adjustments in the nominal exchange rate and we offer some explanations for the relatively rapid convergence towards PPP.