A financial crisis is often associated with a bank run where investors sell off assets or withdraw money from savings accounts.
This is driven by the fear that the value of those assets would drop if they remain in a financial institution.
If left unchecked, a financial crisis can cause an economy to go into a recession or depression.
In the event of a recession, there would be a widespread decline in economic activity, lasting more than a few months.
The slowdown is normally visible in real gross domestic product (GDP), real income, employment, industrial production and wholesale-retail sales.
An economic depression would mean a more severe version of a recession. E.g. the Great Depression in the U.S. (as well as the world) starting in 1929 and continuing to the early 1940s
What is the post-2008 scenario?
An overview of the decade since the global financial crisis of 2008 signals global recovery and rebound in the United States economy.
The bounce-back was strong enough and the US Federal Reserve even signalled two rate hikes in 2019.
Many global central banks also gave notice that the prolonged phase of easy money was coming to an end.
[Following the 2008 crisis, central banks worldwide cut interest rates to historic lows in order to overcome recession.]
Despite this, Paul Krugman has warned of a recession in the world’s biggest economy, the US, on certain grounds.
What are the recessionary factors?
Debt - The US is in worse fiscal condition than it was in 2008.
U.S. has a huge public debt at a little over $22 trillion and has been growing over the last few years.
The debt-to-GDP ratio (a measure of the ability of a country to repay debt) is rising to 104% now.
Besides, the current leadership in the U.S. favouring too much protectionism is also a cause of worry.
Europe - There is an economic slowdown in Europe due to various factors.
These include economic powerhouse Germany being hit because of tariff wars involving the US and China, a recession in Italy, slowing growth in France, etc.
The European central bank (ECB) cannot cut rates to address these because they are negative already.
Evidently, Europe is clearly experiencing a slowdown to recessionary levels already and has no recourse.
China - For China, the trade war with the US, if not settled, could hamper growth or result in a recession.
Growth in the rest of the world will likely slow down, and more so as other countries will retaliate against US protectionism.
Why is it riskier than 2008 crisis?
The ongoing trade disputes and an unsustainable fiscal stimulus will limit the options for boosting the economy in the event of another crisis.
The top central banks have already massively bought bonds and other assets during the 2008 global financial crisis to ensure easy money.
Given this, the space for fiscal stimulus is limited by the massive public debt.
So they may not have the policy tools to provide easy liquidity, given the liabilities on their existing balance sheets.
So unlike in 2008, the policymakers may not have the sufficient capacity to balance the impact of another recession now.
Possibly, the next crisis and recession, if it comes, could be even more severe and prolonged than the one in 2008.
What is the U.S.'s stance?
In contrast to the above predictions, there is optimism among the financial circles in the U.S.
Inflation is in balance and the jobs or labour market is still strong.
The US Federal Reserve is said to be prepared to adjust policy quickly and flexibly, and to use all its policy tools to support the economy.
It is quite certain of keeping economic expansion on track, the labour market strong and inflation close to 2%.
Should India be worried?
Oil prices, a major threat to macroeconomic stability, have been relatively low.
Foreign flows have moved out a little but domestic investors are putting money into stocks and mutual funds.
If the current scenario continues with low interest rates, an accommodative policy of central banks, and low inflation, the RBI could cut interest rates further.
In all, there is not much cause of worry for India at present.
