Debt, Financial Fragility, and Systemic Risk

Debt, Financial Fragility, and Systemic Risk

Debt, Financial Fragility, and Systemic Risk

Debt, Financial Fragility, and Systemic Risk

Synopsis

A remarkable feature of the period since 1970 has been the patterns of rapid and turbulent change in financing behaviour and financial structure in many advanced countries. These patterns have, in turn, often been marked by rising indebtedness, default on loans and periods of financial instability, whether in the non-financial sectors, the financial sector or both. This book explores, both in theoretical and empirical terms, the nature of the relationships between underlying phenomena; namely levels and changes in borrowing (debt), vulnerability to default in the corporate and household sectors (financial fragility), and widespread disorder in the financial sector (systemic risk). Davis focuses on the wider generality of the phenomena at issue whereby similar patterns are observable in several countries, but not in others, as well as in the international capital markets themselves. Particular attention is paid to the importance of the nature and evolution of financial structure to the genesis of instability. Given the international scope of the analysis, the work is germane to the study of the devlopment of financial systems in all advanced countries, as well as the euromarkets. It will be of particular relevance, however, in the US, Japan, Germany, France, the UK, and Canada, Italy, Australia, Sweden, Norway, Finland, whose experience is examined in detail. In this expanded and revised edition, the macroeconomic consequences of fragility and the appropriate policy response are examined in particular detail, with the analysis focusing on macroeconomic performance in eleven countries over 1988-93. A wide range of issues relating to financial stability, including risk in payments systems, derivatives, and property lending, are also considered.

Excerpt

For an observer of the behaviour of financial markets, a remarkable feature of the period since 1970 has been the patterns of rapid and turbulent change in financing behaviour and financial structure in many advanced countries. These patterns have in turn often been marked by rising indebtedness, volatile asset prices, and periods of financial stress, whether in the non-financial sector, the financial sector, or both. At the same time, the economics profession has seen a notable advance in the scope and depth of the theory of finance, particularly as it relates to the nature and behaviour of financial institutions and markets. This book seeks to confront these developments.

More precisely, the objective of the book is to explore, in both theoretical and empirical terms, the nature of the relationships in advanced industrial economies between levels and changes in borrowing (debt), vulnerability to default in the non-financial sector (financial fragility), and widespread instability in the financial sector (systemic risk). Can theory help us to understand these developments? Have such linkages become more common in recent years? If so, can underlying factors be discerned? Are there differences between the various national and international markets? and what should be the policy response?

The work seeks to provide a survey and critical assessment of current economic theory relating to debt and financial instability, to offer empirical evidence casting light on the validity of the theories, and it suggests a number of policy implications and lines of further research. Unlike most extant texts on these matters, which generally relate to one country's experience (usually the USA), the book focuses on the way similar patterns are observable in several countries--but not in others-- as well as in the international capital markets themselves. in addition, it seeks to provide a balanced approach to the various theoretical analyses of these issues, rather than narrowly focusing on a single preferred line. Third, unlike much recent work, theory is confronted with evidence and judgements drawn from the results. Finally, particular attention is paid to the importance of the nature and evolution of financial structure to the genesis of instability. Whereas a structural approach is common in analysis of comparative behaviour of financial systems--notably in corporate finance--its application to instability is relatively rare.

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