Modeling Financial Crises: A Schematic Approach

What is now known as Post Keynesian economics began with John Maynard Keynes’ efforts to explain the greatest crisis in the history of capitalism. Among his conclusions were that such incidents were systemic and that, unless serious reforms were implemented, they would tend to grow in frequency and severity. Today, we again find ourselves in the midst of global financial collapse. Addressing our current problems and protecting ourselves from repeat performances requires that we understand the essential character of crises. The opening stage of a crisis may take a number of forms: collapsing currency prices, the bankruptcy of financial intermediaries, Minsky moments, stock market crashes, et cetera. It is the premise of this paper that all such events arise from a common set of fundamental factors, but follow different paths. In addition, a crisis may build in one sector of the economy but not another, or developments may be parallel. And even if initially isolated, once realized the crash may trigger similar events in otherwise-sound areas of the economy. The goal of this paper is to build a model of crises that captures both the unique characteristics of each type and their common roots. A schematic method is employed that traces the processes in time and shows how events become interrelated and mutually causal