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Costs of financial instability, household-sector balance sheets and consumption

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  • Barrell, Ray
  • Davis, E. Philip
  • Pomerantz, Olga

Abstract

The literature on costs of financial instability tends to focus on fiscal costs and the impact on GDP of banking crises. In this paper we analyse the effect of a banking or currency crisis on consumption. We show that consumption plays an important role in the macroeconomic adjustment following a financial crisis. Furthermore, the effect of a crisis is aggravated by high leverage, notably as shown by the effect of a high debt-income ratio, despite the benefits of financial liberalisation in easing liquidity constraints. It is also greater in a small open economy than in the G-7. Meanwhile, falling house prices are shown to be part of the transmission process of financial instability, and high nominal interest rates are an indicator of sharp declines in consumption. A simulation for a banking crisis underlines the important role of monetary and fiscal policy in easing the impact of a financial crisis on consumption and other expenditure components. Viewed in the light of growing gearing, or leverage, in recent years, the results imply that a banking crisis taking place now could have a greater incidence than in the past, especially if macroeconomic policy is unable to respond, as for a small country in EMU. View Press release: Banking Crises and Consumption (74kb), Tuesday 20th July 2004

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Stability.

Volume (Year): 2 (2006)
Issue (Month): 2 (June)
Pages: 194-216

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Handle: RePEc:eee:finsta:v:2:y:2006:i:2:p:194-216

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Web page: http://www.elsevier.com/locate/jfstabil

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Cited by:
  1. Gerlach-Kristen, Petra & O'Connell, Brian & O'Toole, Conor, 2013. "How do banking crises affect aggregate consumption? Evidence from international crisis episodes," Papers WP464, Economic and Social Research Institute (ESRI).
  2. Thomas Piketty, 2010. "On the long-run evolution of inheritance: France 1820-2050," PSE Working Papers halshs-00564853, HAL.
  3. Q. Akram & Gunnar Bårdsen & Kjersti-Gro Lindquist, 2007. "Pursuing financial stability under an inflation-targeting regime," Annals of Finance, Springer, vol. 3(1), pages 131-153, January.
  4. Petr Jakubík, 2011. "Household Balance Sheets and Economic Crisis," Working Papers IES 2011/20, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jun 2011.
  5. Eilev Jansen, 2013. "Wealth effects on consumption in financial crises: the case of Norway," Empirical Economics, Springer, vol. 45(2), pages 873-904, October.
  6. Tabak, Benjamin M. & Luduvice, André Victor D. & Cajueiro, Daniel O., 2011. "Modeling default probabilities: The case of Brazil," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 513-534, October.
  7. Karim, Dilruba & Liadze, Iana & Barrell, Ray & Davis, E. Philip, 2013. "Off-balance sheet exposures and banking crises in OECD countries," Journal of Financial Stability, Elsevier, vol. 9(4), pages 673-681.
  8. Christopher Kent & Crystal Ossolinski & Luke Willard, 2007. "The Rise of Household Indebtedness," RBA Annual Conference Volume, in: Christopher Kent & Jeremy Lawson (ed.), The Structure and Resilience of the Financial System Reserve Bank of Australia.
  9. Na Guo & Peter N. Smith, 2012. "Durable Consumption, Long-Run Risk and The Equity Premium," Discussion Papers 12/37, Department of Economics, University of York.
  10. Schou-Zibell, Lotte & Albert, Jose Ramon & Song, Lei Lei, 2010. "A Macroprudential Framework for Monitoring and Examining Financial Soundness," Working Papers on Regional Economic Integration 43, Asian Development Bank.
  11. Higgins, Eric & Calomiris, Charles, 2011. "Policy Briefings: Are Delays to the Foreclosure Process a Good Thing?," Working paper 641, Regulation2point0.
  12. Theophilos Papadimitriou & Periklis Gogas & Benjamin M. Tabak, 2013. "Complex Networks and Banking Systems Supervision," Working Papers Series 306, Central Bank of Brazil, Research Department.

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