Click Here To Purchase The Global Economic System: How Liquidity Shocks Affect Financial Institutions and Lead to Economic Crises

Authors: George Chacko, Carolyn Evans, Hans Gunawan, Anders Sjoman

The Great Depression of 2008-09 in the global economy which primarily originated in the U.S. has been likened to the Great Depression of the 1930s in the U.S. and the Lost Decade in Japan during the 1990s.

The Global Economic System seeks to provide an intuitive framework for thinking about the sequence of events that occur from the initial trigger that causes the crash through a liquidity shock to the aftermath of the crisis. 

Starting with a motivation to understand liquidity risk, the book gives examples such as Worldcom and an analysis of hedge fund historical performance to show how liquidity has been the key reason for many of these crisis episodes.

Concepts of liquidity risk including a more rigorous definition and how it manifests are then introduced with a generally accessible overview of the models of liquidity risk. In this context there is coverage of the different financial instruments and the role of banks and other institutions which are key in understanding the progress of the crisis.

The bulk of the book is taken by applying the liquidity shock framework in explaining how three major crisis - Great Depression, Lost Decade and Great Recession - unfolded. The trigger for the crisis, change in liquidity demanded, change in balance sheets and impact on the real economy is explained.

While the central framework itself deals with the progress of the crisis and its aftermath, the book gives a great summary of the economic conditions prior to the crisis where the seeds of the crisis were planted. This gives a great background in comparing the different crises while appreciating the similarities.

Though each of the cases, the authors provide a set of key indicators and charts that highlight the happenings in the economy and financial system, giving a tangible feel to the developments in the system. Also, in each of the cases, the authors highlight special features particular to the crisis which made it different from others. 

In case of Japan Lost Decade, the authors highlight the ever greening of non performing loans which led to the impact dragging on for more than a decade. In case of the U.S. Great Recession, the authors highlight the changes in institutions, instruments and markets which amplified the extent of damage as compared to other crises.

Finally, the book closes with some policy recommendations for mitigating the impact of liquidity crisis and to recover from such a crisis. The book provides a great framework to understanding and to analyze liquidity driven financial crisis in terms of the unfolding of events, actions taken by the players and  the impact on the real economy.