Shocks, Crises, and their Determinants

The current global financial crisis is the most serious both in terms of magnitude and scope since the Great Depression. No country has been immune to the economic slowdown. In advanced economies, the financial crisis and the global recession that followed the burst of the global financial bubble have brought severe consequences in terms of employment and output. In developing countries, output contraction, growth slowdown, and rising unemployment came hand in hand with higher borrowing costs, sluggish export growth, and a significant reduction in international capital flows. As a result, poverty has increased. The global financial crisis has left lasting effects on the structure of financial markets, international capital flows, and the cost of capital for developing countries. The efforts of governments and international financial institutions to buffer the impact of the crisis have been quick and aimed in the right direction. However, many risks remain for the road to recovery. This paper provides a brief explanation of how the current global financial crisis originated, and the underlying factors that turned a relatively small collapse in the U.S. subprime mortgage market into a global crisis. Next it explores similarities and differences between the current crisis and past experiences. This comparison can provide us with a better understanding of the main determinants and transmission mechanisms involved, which can help us design a better response to the current situation on the one hand, and prevent future crises or minimize their impact on the other. Finally, lessons that can be learned for developing countries are discussed, focusing on policies governments can implement to mitigate the effects of crises and factors that are important for reducing the risks of experiencing a crisis.