A Business-Cycle Model
of Financial Crises
A business-cycle model of financial crises attempts to specify the conditions that develop over the course of the business-cycle expansion that make a financial crisis likely to occur near the peak.
The model does not assume that financial crises must occur at the peak of the business cycle, nor does it rule out crises at other times. Nonetheless, it is asserted that financial crises do occur as a result of systematic forces that take place near the peak of the business-cycle expansion, and that the model presented here accurately accounts for the crises that have appeared at the last six business-cycle peaks.
The model is constructed by beginning with the business-cycle, credit-market perspective discussed in chapter 3. It is then filled out primarily by addressing the issues that divide the various theorists. These issues, as noted in chapter 3, include (1) the reasons for the development of financial difficulties in the business sector, (2) the factors influencing the demand and supply of credit, and (3) the defining patterns of a financial crisis.
The resolution of these issues, at this point, represents the author's interpretation of how the crises discussed in Part II—those near the cyclical peaks—developed. For the time being, the crises occurring during the 1983-90 expansion will be ignored. The financial crisis involving the Bank of New England in January 1991, occurring as it did six months after the cyclical peak in July 1990, will be considered in the cyclical context. The model itself is an attempt to generalize the specific cyclical events of Part II into a coherent overall explanation. In the next chapter, an attempt will be made to evaluate the model. It is perhaps best understood as focusing on business-cycle developments, of how these developments make a financial crisis likely at the peak, rather than as a comprehensive theory of financial crises. Chapters 13 and 14 will try to get closer to that general understanding of financial crises by considering reasons for those crises that did not occur near the business-cycle peaks.