What is an Economic Crisis?
In any complex system, a crisis is a period of where the system functions very poorly, warranting immediate corrective action. In an economy therefore, a crisis can be described as that period of dismal economic performance. During this time, the value of institutions, especially financial institutions, drops at unprecedented speeds and everything seems to be valueless. Production is low and often fails to meet the level of demand.
Causes of an economic crisis
Since most economic crises are unexpected, it is usually difficult to determine the exact cause of the crisis. However, there are a number of situations that provide the setting for an economic. It is important to note that the presence of these conditions does not automatically lead to an economic crisis. An economy is a very complex system, and for such a system to dysfunction, the conditions have to be persistent over a long period of time. Here are some of the causes of an economic crisis:
When participants in a market are uncertain about issues such as the expected value of stocks and securities, then they are unlikely to trade in the same manner that they used to. Investors will shy away from the particular market, resulting in cash flow problems as well as reduced trading. The reasons for uncertainty range quite widely, from political instability to change in government policy. Uncertainty is presumed to be one of the most prolific contributors to economic crises all over the world.
When the there is rampant mismanagement of funds, both in the public sector and in the private sector, an economy loses a lot of money, leading to cash flow problems. Furthermore, investors lose confidence in that economy because they are not assured of returns for their investments. Investors therefore withdraw their investments and chose to invest elsewhere. When this occurs, then an economic crisis is imminent.
When a country experiences recession, then the countries that it trades with will be affected too. This is especially true about modern world economies, which are closely intertwined. A good example is in Europe where the euro is a common currency for all countries in the European Union. If the economy of one European country fails, it is inevitable that other countries will carry the burden too. This is partly because the value of that common currency will drop, leading to a drop in the value of assets and institutions in all the member countries.
Mismatch between assets and liabilities
Where banks and financial institutions are concerned, a possible cause of crisis would be a mismatch between the assets and the liabilities of the bank. For example, modern banks have accounts which allow customers to withdraw cash anytime they want. But the banks are supposed to use the proceeds from these deposits to provide loans which are long term. Chances are that at some point, there will not be enough cash for the bank because the account holders will have withdrawn it all.
Dealing with a crisis
Handling an economic crisis is quite a complicated affair, which depends largely on the nature of the crisis itself. But it is always important when trying to avert a crisis, to think long term, rather than looking for quick fixes.