How financial crises develop http://forumblog.org/2014/11/how-financial-crises-develop/ By Aitor Erce and Irina Balteanu Nov 12 2014 " The feedback loop between fiscal and financial instability has been at the core of the recent turmoil in Europe (Acharya et al. 2014). In some countries, systemic banking crises triggered fiscal distress due to the magnitude of bank rescue operations (for example, in Ireland). In others, substantial sovereign debt tensions, leading to successive sovereign downgrades, severely weakened domestic financial systems (for example, in Greece). Against this background, and despite the fact that the combination of fiscal and financial distress is nothing new to emerging markets, it is surprising that the large literature looking at how different types of crises combine (the so-called ‘twin crises’ literature) has only recently begun to examine the links between banking and sovereign debt crises. Concerning emerging markets, two notable exceptions are Panizza and Borenzstein (2008) and Reinhart and Rogoff (2011). These papers document the existence of feedback between banking and sovereign crises, but do not study the channels of transmission formally.1 In Balteanu and Erce (2014), we fill this gap by studying the behaviour of a set of macro-financial variables through which feedback loops of fiscal and financial stress may materialise. New to the literature, we differentiate twin events according to whether they are triggered by a banking or a debt crisis. ... Timing matters Apart from the systematic differences between ‘single’ and ‘twin’ crises, our analysis also shows that ‘twin’ crises themselves are far from being homogenous events. By taking into account the different sequence of crises during ‘twin’ episodes, we are able to uncover significant differences between the two types of ‘twin’ crises, both in terms of levels and dynamics, which would have otherwise gone unnoticed – such as those of budget deficits, inflation rates, credit to the private sector, or capital flows. This is a relevant result, given that the twin-crises literature does not typically distinguish twin crises according to the original shock. Conclusions By providing a detailed understanding of the economic dynamics around different crisis episodes, the event study discussed in this column can inform the design of theoretical models. In fact, a number of empirical facts usually associated with either ‘banking’ or ‘debt’ crises in the literature are to be found in ‘twin’ events only. Moreover, these results show that considering the sequence of crises within ‘twin’ events is important for understanding their transmission channels and economic consequences. Disclaimer: The views in this column are the authors’ and should not be reported as those of the European Stability Mechanism, the Bank of Spain, or the Euro-System. "