May 30, 2019 Reading Time: 3 minutes

During a financial crisis, like the one the United States experienced in 2007-8, it is clear to everyone that something is wrong with the economy. What is not clear is whether government policies can do anything to fix the problem and, if so, what form those policies should take. If government policy is viable, the nature of the shock will determine what kind of policies should be pursued. If banks have reduced lending to productive ventures, for example, policies aimed at boosting consumer spending are unlikely to improve matters. Likewise, if consumer confidence is the source of the shock, it makes little sense to encourage further production through investment tax credits and the like. So, do financial crises usually stem from the demand or supply side of the market?

Ultimately, this is an empirical question. And, in a new NBER working paper, Felipe Benguria and Alan M. Taylor attempt to answer it.

Benguria and Taylor look to global international trade data. First, they show how financial crises have a large impact on international trade. Figure 3 (below) highlights how world trade is greatly affected by major financial crises. The red dotted lines highlight four important crises. This gives them a reason to believe there is an important connection between financial crises and international trade.

Next, they use a simple macroeconomic model to show how shocks on the demand and supply sides of an economy affect a country’s international trade. A shock on the demand side causes imports to decline, as households buy fewer goods; but exports remain largely unchanged, as firms can continue to sell abroad. As a result, the real exchange rate depreciates. A shock on the supply side, in contrast, causes exports to decline, as firms produce fewer goods; but imports remain largely unchanged, as households continue to buy from abroad. In this case, the real exchange rate appreciates.

With these observations in hand, the authors look at the historical data and argue that financial crises tend to stem from the demand side of the market. They compile the largest possible crossed dataset of 200+ years of trade flow data and the timing of around 200 financial crises across many countries.

The authors use a series of regressions to calculate an “average” financial crisis and trace out its effects over time. Figure 4 (below) plots the percentage change of exports or imports divided by GDP, where the change is taken from the date of the financial crisis, which is normalized to be time zero. This average financial crisis shows little effect on exports, but a large decline in imports.

As is standard in economics papers, they look at the data from many angles. But their empirical evidence remains strikingly unambiguous: after a financial crisis, the dominant pattern is that imports decline, exports hold steady or even rise, and the real exchange rate depreciates. “History shows,” the authors conclude, “that, on average, financial crises are very clearly a negative shock to demand.”

Brian C. Albrecht


Brian C. Albrecht is an assistant professor of economics at Kennesaw State University. His research interests include political economy and monetary economics. He has published articles in scholarly journals, including the Journal of Economic Methodology and the NYU Journal of Law & Liberty.

Albrecht earned his M.A. in Economics from the University of Minnesota, his M.Sc. in Economics of Public Policy from the Barcelona Graduate School of Economics, and his B.A. in Physics and Political Science from St. Olaf College.

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