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Financial Crises: Understanding the Postwar U.S. Experience

By Martin H. Wolfson | Go to book overview

12
Evaluating the Business-Cycle Model

This chapter will evaluate the accuracy of the business-cycle model of financial crises discussed in chapter 11. The financial crises and related business-cycle developments during the postwar period will be examined to see if they are generally consistent with the main features of the model.

In approaching this investigation, how should we evaluate the obvious exceptions: those crises described in chapters 9 and 10 that appeared before the peak of the business-cycle expansion, that apparently fall outside the purview of the business-cycle model? If the model is taken to be an all-inclusive explanation of the necessary and sufficient conditions for financial crises, then the recent crises clearly are evidence against the model. However, the model should not be interpreted as implying either that financial crises must occur at the peak of the business-cycle expansion, or that financial crises cannot occur at other times. Rather the model specifies those conditions that develop during the expansion that make financial crises likely at the peak. A more complete understanding of financial crises, and their significance for the functioning of the economy and the financial system, is explored in chapters 13 and 14.

The more modest task attempted in this chapter is to examine the consistency of the business-cycle model of financial crises with developments at the six most recent business-cycle peaks (including the peak preceding the growth recession of 1966). The business-cycle experience in the postwar period before 1961 will not be considered.

In carrying out this evaluation, it is useful to recognize that the business‐ cycle model encompasses two different but interrelated phases. In the first phase, the conditions develop that make the economic system vulnerable to the outbreak of a financial crisis. In the second phase, the crisis itself unfolds. In the summary of the model given at the end of the previous chapter, the first phase is represented by the first five points; the second phase, by the next four.

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