Financial Instability and Financial Crises : An Empirical Study of the Implications of Financial Instability for the Development of Financial Crises.

Abstract

The objective of this master thesis was to examine how financial instability manifest during Norwegian financial crises in the period 1899-2010. To answer our research question, we have analyzed financial and macroeconomic indicators during seven crises. This approach allowed us to assess whether a recurring pattern in indicators emerged during multiple crisis periods. Firstly, we presented the crisis theories of Minsky, Kindleberger, Grytten, and Hunnes, aimed at explaining the upbuilding of financial crises. Secondly, we evaluated eleven financial and macroeconomic variables, which constituted the foundation of our data material. Thirdly, we outlined important characteristics of seven economic crises, to provide insight into the historical context of Norwegian financial crises. Collectively, these sections formed the foundation for our analysis and discussion. To analyze the implications of financial instability, we conducted a deviation analysis and correlation analysis. The deviation analysis involved studying the changes in macroeconomic variables by decomposing the time series using an HP-filter. Additionally, the correlation analysis allowed us to examine the relationship between the monetary indicators and fluctuations in asset prices. The results from our deviation analysis revealed a procyclical pattern in a majority of the examined macroeconomic indicators, with the only exceptions being bankruptcies and unemployment. The latter variables exhibited a countercyclical pattern. Furthermore, the correlation analysis revealed that the monetary indicators correlated with housing prices during the interwar crises. During the other crises, the correlation analysis revealed a pattern of credit tightening following the turning points in the housing and stock markets. Collectively, these findings suggested a correspondence between the development in financial and macroeconomic indicators, and the upbuilding of crises outlined in the theoretical framework. Hence, the pattern observed for all indicators aligned with the frameworks of Minsky and Kindleberger. Overall, our findings have emphasized the significance of financial instability in the progression of financial crises.