The Prognostics for Credit Shocks (Financial Crisis) and Insights for Mitigating Consequences

Abstract

Credit shocks are organic phenomena in economy but extreme biases could have harm effect both at micro and macro level. Many econometric models have been constructed based on various theoretical approaches (neoclassical economics, Keynesian, business cycle, post Keynesian and others) aiming to predict peaks and pitfalls in the economies. But unfortunately many of them were misleading in predicting 2007-2008 financial crisis and long lasting recession afterwards. The literature indicates plenty of negative aspects of recent financial crisis at macro-level including decrease in consumption, aggregate demand and investment, financial markets' stagnation, increase in Government debt and unemployment rate and even more political instability. While effects at micro level encompass the decline in business loans, fall in equity value, property devaluation, decrease in sales, increase in defaults, decrease in investment in R&D and etc. Especially small open economies, like Lithuania, have suffered most in terms of shrinkage of GDP during the 2007-2009 period. Therefore the qualitative approach is valuable in deepening the knowledge about the preconditions and consequences of credit shocks. Thus this study aims to extract the main prerequisites and outcomes for credit shocks and to approve it by the expert opinion. Expert evaluation results indicate that absence of reserve funds was the most important precondition for 2007-2008 crisis and recession. Moreover when the gathered unplanned cyclical income have been wasted and even more the public sector spending has been increased that led to even bigger budget deficit. Also experts unanimously identified the main consequences of credit shock and 2007-2009 crisis including: (1) Decrease in GDP and government revenues, (2) Fall in domestic demand in Lithuania and increase in importance of exports for economic development, (3) The decline in consumption level and the delay of purchase, and (4) Shrinkage of construction sector, and manufacturing and trade of durable goods.

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