While financial crises have common elements, they do come in many forms. A financial crisis is often associated with one or more of the following phenomena: substantial changes in credit volume and asset prices; severe disruptions in financial intermediation and the supply of external financing to various actors in the economy; large scale balance sheet problems (of firms, households, financial intermediaries and sovereigns); and large scale government support (in the form of liquidity support and recapitalization). As such, financial crises are typically multidimensional events and can be hard to characterize using a single indicator.  The literature has clarified some of the factors driving crises, but it remains a challenge to definitively identify their deeper causes.

Many theories have been developed over the years regarding the underlying causes of crises. While fundamental factors—macroeconomic imbalances, internal or external shocks—are often observed, many questions remain on the exact causes of crises. Financial crises sometimes appear to be driven by “irrational” factors.

These include sudden runs on banks, contagion and spillovers among financial markets, limits to arbitrage during times of stress, emergence of asset busts, credit crunches, and firesales, and other aspects related to financial turmoil. Indeed, the idea of “animal spirits” (as a source of financial market movements) has long occupied a significant space in the literature attempting to explain crises (Keynes, 1930; Minsky, 1975; Kindleberger, 1978).3   Financial crises are often preceded by asset and credit booms that eventually turn into busts. Many theories focusing on the sources of crises have recognized the importance of booms in asset and credit markets. However, explaining why asset price bubbles or credit booms are allowed to continue and eventually become unsustainable and turn into busts or crunches has been challenging. This naturally requires answering why neither financial market participants nor policy makers foresee the risks and attempt to slow down the expansion of credit and increase in asset prices.

   The dynamics of macroeconomic and financial variables around crises have been extensively studied. Empirical studies have documented the various phases of financial crises, from initial, small-scale financial disruptions to large-scale national, regional, or even global crises. They have also described how, in the aftermath of financial crises, asset prices and credit growth can remain depressed for a long time and how crises can have long-lasting consequences for the real economy.

Given their central roles, we next briefly discuss developments in asset and credit markets around financial crises. 


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