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

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

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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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
Contact details of provider: Web page: http://www.elsevier.com/locate/jfstabil

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  15. Joseph P. Byrne & E. Philip Davis, 2003. "Disaggregate Wealth and Aggregate Consumption: an Investigation of Empirical Relationships for the G7," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(2), pages 197-220, 05.
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