Predictable Financial Crises

Abstract

Using historical data on postwar financial crises around the world, we show that the combination of rapid credit and asset price growth over the prior three years, whether in the nonfinancial business or the household sector, is associated with a 40% probability of entering a financial crisis within the next three years. This compares with a roughly 7% probability in normal times, when neither credit nor asset price growth is elevated. Our evidence challenges the view that financial crises are unpredictable “bolts from the sky” and supports the Kindleberger‐Minsky view that crises are the byproduct of predictable, boom‐bust credit cycles. This predictability favors policies that lean against incipient credit‐market booms.

Will a boom be followed by crash? A new systemic risk measure based on right-tail risk

“…risk and right-tail risk, where the AIC is applied to determine the optimal lag order, and then examine the leading-lag relationship between them. For instance,  r Alternatively, right-tail risk has a stronger forward-looking predictive power for left-tail risk, implying that the rapid asset price boom in the short term is indeed a great early warning indicator of financial crises (Borio and Lowe, 2002;Schularick and Taylor, 2012;Krishnamurthy and Li, 2020;Greenwood et al, 2022).…”

“…As shown in Table 7 , apart from the absence of Granger causality between and , right-tail risk is a one-way Granger cause of left-tail risk in the remaining groups. Alternatively, right-tail risk has a stronger forward-looking predictive power for left-tail risk, implying that the rapid asset price boom in the short term is indeed a great early warning indicator of financial crises ( Borio and Lowe, 2002 ; Schularick and Taylor, 2012 ; Krishnamurthy and Li, 2020 ; Greenwood et al, 2022 ).…”

“…Although it has been argued that financial crises are sudden and highly unpredictable financial market tail events ( Cole and Kehoe, 2000 ; Chari and Kehoe, 2003 ; Gorton et al, 2012 ), typically accompanied by a recession in economic fundamentals ( Kaminsky and Reinhart, 1999 ), the prevailing view is that financial crises can be predicted by identifying rapid asset price booms in the short term ( Minsky, 1977 , 1986 ; Kindleberger, 1978 ). According to several studies ( Borio and Lowe, 2002 ; Schularick and Taylor, 2012 ), fast asset price growth in the short term is a valuable early warning crisis indicator that can accurately forecast financial vulnerability ( Greenwood and Hanson, 2013 ; Baron and Xiong, 2017 ; López-Salido et al, 2017 ; Mian et al, 2017 ; Krishnamurthy and Li, 2020 ; Greenwood et al, 2022 ). The current literature on systemic risk focuses primarily on left-tail risk, which can lead to direct losses, as such risk can be contagious across firms, industries, and markets based on multiple channels, causing risk resonance throughout the entire financial market and negative externalities for the real economy.…”

Will Indonesia enter the 2023 financial crisis? Application of early warning model system

“…Many studies found that the pre-crisis event and impact of the economic and financial crisis in a country can be detected by economic models (Greenwood et al, 2022;Reinhart et al, 2000;Goldstein et al, 2000;Bussiere & Fratzscher, 2002). If it is unpredictable, financial crises can cause severe economic costs in the form of slowing economic growth, decreased output, corporate bankruptcies, layoffs, financial sector instability, decreased credit distribution, and others (Krugman, 1999;Chen & Svirydzenka, 2021;Hutchison & Noy, 2006;Claessens et al, 2012;Claessens & Kose, 2013a;Claessens & Kose, 2013b;IMF, 2022;Pritsker, 2013).…”

Analyst Research Activity During the COVID‐19 Pandemic

“…Greenwood et al . (2022, p. 863) document that economic crises, including the 2007 financial crisis, are predictable; they argue that their ‘evidence challenges the view that financial crises are unpredictable “bolts from the sky” and supports the Kindleberger‐Minsky view that crises are the byproduct of predictable, boom‐bust credit cycles’. If financial crises are predictable, analysts can use past knowledge to understand when a financial crisis is likely to take place and how it will affect firms’ behaviour.…”