FISCAL CRISIS PUBLIC FINANCE WAI HONG CHAN 80046

DEFINITION: FISCAL CRISIS VS FINANCIAL CRISIS • Fiscal crisis: Inability of a government to manage debt loads and deficit between tax revenue and expenditure. 1 • Financial crisis: Systemic problems within the financial sector of an economy that results in economic recession. 2 • Interrelated 3 Ø Financial crisis Fiscal crisis Ø Fiscal crisis Financial crisis 1, 2: Financial vs. Fiscal Crises: A 21 st Century Primer(2011) 3: On the Prevention of Crises in the Eurozone

TWO COMMON CRISIS 1. (Sovereign) Debt Crisis 2. Banking Crisis

(SOVEREIGN) DEBT CRISIS 1 • Inability of a country to repay its debt without assistance of third parties • How it happens? • Government finances its expenditure mainly by • 1. Tax revenue • 2. Issuing debts • If debt level is too high, investors may worry about the ability of repaying debt • Investors require higher interest rate (compensate for higher risk) 1: Debt Crisis

(SOVEREIGN) DEBT CRISIS 1 •

EUROPEAN DEBT CRISIS 1 (2009) • World’s great threat since 2008 Global financial crisis Overviews • Greece and Italy : • High level of debt • credit ratings lowered (interest rate increases) • Loss of confidence • Unable to repay debt • Asks EU for help 1: Sovereign Debt Crisis with Examples

EUROPEAN DEBT CRISIS 1 (2009) • Spain and Ireland: • Banks heavily invested in real estate bubbles • Price fall due to 2008 financial crisis • Governments cover banks’ loss and debt • Large debt loads and government deficit • Ask EU for help • EU: • Enforce austerity policy • More difficult for countries to repay debt • Vicious cycle • Economic recession 1: Sovereign Debt Crisis with Examples

EUROPEAN DEBT CRISIS (2009) • Consequence: 1: Wiki

BANKING CRISIS 1 • How it happens? • Basic of Banking: Borrowing short and lending long • Use deposits to invest in long-term high-risk project • If public distrust the bank and withdraw deposits at the same time (bank run) Banks are hard to satisfy deposits (Liquidity Crisis) • Bank run can spread over the country and become bank panic which can result in systemic banking crisis 1: The Banking Crisis: Causes, Consequences and Remedies

BANKING CRISIS • Other explanation: • Banking crisis can be caused by 2 types of events 1 1. Bank runs that result in closure, merging, or takeover by third parties 2. No bank runs, closure, merging or takeover but large-scale government assistance of an/a group of important bank(s) 1: The Twin Crises: The Causes of Banking and Balance-of-Payments Problems(p. 9)

BANKING CRISIS • Impacts of banking crisis 1. Decline in investment level 1 • Banks lack liquidity less willing to lend loan to firms • Firms are difficult to finance investment reduce investment • GDP decreases aggregate demand decreases 2. Unemployment 2 • Banks cut cost lay off labours • Firms produce less lay off labours 1, 2: Impact of a banking crisis

BANKING CRISIS • Impacts of banking crisis 3. Induce fiscal cost for government 1 • In order to stabilize banking industry Government interventions • Provide liquidity support • Compensate for depositors • Heavy fiscal burden may enter into fiscal crisis 1: From Systemic Banking Crises to Fiscal Costs: Risk Factors

EXAMPLE: 2008 FINANCIAL CRISIS • Worst financial crisis since the Great Depression • Over 400 banks fail from 2008 to 20101 • U. S unemployment rate increase to 7. 2%2 • Highest rate since 1993 • Lehman Brothers Bankruptcy 3 • Share price dropped over 40% in a single trading day 1: Bank Failures in Brief 2: Worst year for jobs since ‘ 45 3: Financial Banking Crisis 2008