Economic Disturbances and Equilibrium in an Integrated Global Economy

Chapter 33

The Financial Crisis: Could We Have Avoided It or At Least Minimize Its Impact?

Abstract

The credit market’s innovations facilitated a credit expansion. Combined with a prosperous economy and declining long-term interest rates, it fueled an increase in expenditures, which led to an increase in the leverage and debt service of the economy. The increased debt made the economy vulnerable to an asset decline, which would reduce the credit worthiness of the borrowers and capital adequacy of the lending institutions. We argue that a few years into the cycle, it would trigger a scaling back of the credit-creation process, and that would create a vicious cycle if unchecked. Whether a vicious cycle develops or not, and how strong such a cycle ...