6.3 Global Financial Crises and Their Consequences

Global financial crises can shake the world economy, causing ripple effects across nations. From asset bubbles to banking vulnerabilities, these crises stem from various factors that intertwine and amplify each other, leading to widespread economic turmoil.

The fallout from these crises impacts international trade, reducing demand and disrupting supply chains. Policymakers respond with tools like monetary interventions and fiscal stimulus, but long-term consequences often persist, reshaping economic landscapes and altering risk perceptions for years to come.

Causes and Impacts of Global Financial Crises

Causes of global financial crises

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• Asset bubbles inflate prices beyond fundamental values (housing market in 2008, dot-com boom in late 1990s)
• Excessive leverage amplifies financial risks (Lehman Brothers with 31:1 leverage ratio in 2007)
• Banking system vulnerabilities expose institutions to shocks (inadequate stress testing before 2008 crisis)
• Currency crises destabilize economies (1997 Asian Financial Crisis, 1994 Mexican Peso Crisis)
• Contagion effects spread financial distress across borders (2010-2012 Eurozone Crisis)
• Regulatory failures allow risky practices to proliferate (repeal of Glass-Steagall Act in 1999)

Impact on international trade

• Reduced global demand shrinks trade volumes (global trade fell 12% in 2009)
• Trade finance constraints hinder cross-border transactions (trade finance gap reached $1.5 trillion in 2020)
• Exchange rate volatility complicates international pricing (Brexit vote caused 10% drop in GBP)
• Foreign direct investment (FDI) declines as investors retreat (global FDI fell 42% in 2020)
• Supply chain disruptions disrupt production flows (2011 Thailand floods affected global hard drive production)
• Protectionist measures restrict trade flows (US-China trade war tariffs since 2018)

Policy Responses and Long-term Consequences

Effectiveness of policy responses

• Monetary policy interventions aim to stabilize financial markets (Fed lowered rates to near-zero in 2008)
• Fiscal stimulus measures boost aggregate demand (American Recovery and Reinvestment Act of 2009, $787 billion)
• Financial sector reforms strengthen system resilience (Basel III increased capital requirements)
• International coordination addresses global challenges (G20 London Summit 2009 agreed on $1.1 trillion support package)
• Bank bailouts prevent systemic collapse (TARP provided $700 billion to stabilize US financial system)
• Macroprudential policies mitigate systemic risks (Bank of England's Financial Policy Committee established 2013)

Long-term economic consequences

• Persistent output gaps slow economic recovery (US GDP took 3 years to recover to pre-crisis levels after 2008)
• Increased public debt levels burden future generations (US debt-to-GDP ratio rose from 64% in 2007 to 106% in 2020)
• Structural changes reshape industry landscapes (rise of fintech after 2008 crisis)
• Altered risk perceptions influence investment strategies (increased demand for safe-haven assets like gold)
• Demographic impacts affect long-term economic trends (millennials delayed homeownership after 2008 crisis)
• Technological acceleration transforms business models (rapid adoption of e-commerce during COVID-19 pandemic)