The run-up to the global financial crisis: A longer historical view of financial liberalization, capital inflows, and asset bubbles

Saktinil Roy, David M. Kemme

    Research output: Contribution to journalJournal Articlepeer-review

    28 Citations (Scopus)

    Abstract

    Using forecast error and sensitivity analyses with a vector error correction model for the US economy, we find that the specific exogenous shocks that contributed to the run-up to the global financial crisis of 2007–2009 vary across the three time periods (1980–1988; 1989–1997; and 1998–2006) that are known for distinctive historical events. Deregulation in the 1980s and capital inflows in the early and mid-1990s triggered by the collapse of the European exchange rate mechanism contributed significantly to changes in real house prices. However, capital inflows after the Asian financial crises in 1997 were driven in large part by rising asset prices. Thus, there were interesting changes in the nature of exogenous shocks and directions of causality through the three sub-periods. These results are robust even after controlling for the exogenous global factors partly determining short-run changes in capital flows, asset prices, and per capita real GDP. We conclude that all of the short run changes in response to financial deregulation starting in the 1980s, surges in capital inflows in the early 1990s, and people's expectation of ever-rising asset prices in the late 1990s and early 2000s culminated in the crisis of 2007–2009.

    Original languageEnglish
    Article number101377
    JournalInternational Review of Financial Analysis
    Volume69
    DOIs
    Publication statusPublished - May 2020

    Keywords

    • Asset bubbles
    • Capital flows
    • Financial crisis
    • VEC model

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