CHAPTER 4. FINANCIAL STRESS AND ECONOMIC DOWNTURNS
- International Monetary Fund. Research Dept.
- Published Date:
- October 2008
This chapter examines why some episodes of financial stress lead to economic downturns and others have only a limited impact on the overall economy. The analysis indicates that episodes of financial turmoil characterized by banking sector distress are more likely to be associated with severe and protracted downturns than episodes of stress centered mainly in securities or foreign exchange markets. Countries with more arm’s-length financial systems seem particularly vulnerable to sharp contractions in economic activity, because of the greater procyclicality of leverage in their banking systems. This chapter draws implications for economic prospects in the United States and the euro area and considers how policy responses could help limit the output consequences of the current and future financial crises.