The important issue that arises when considering an early warning system is what exactly constitutes a crisis.a A useful starting point is the IMF taxonomy in World Economic Outlook,b which classifies crises into the following types:

• Currency crisis - when there is a significant devaluation of a currency with loss of reserves and/or a significant rise in interest rates in an attempt to defend the currency, caused by a speculative attack on the currency or a sudden unexpected event
• Banking crisis - when potential or actual bank failure or bank run causes banks to suspend internal servicing of their liabilities or leads to large-scale government intervention
• Foreign debt crisis - when a country cannot service its foreign debt, whether public or private

An alternative classification of crises has been provided by Radelet and Sachs.c While the IMF classification focuses on the manifestations of crises, the Radelet-Sachs classification focuses on the possible causes:

• Macroeconomic policy-induced crisis - this basically follows from Krugman's analysisd of excessive domestic credit expansion being inconsistent with the pegged level of the exchange rate
• Financial panic - a situation of multiple equilibria where adverse equilibria occur. Each creditor rationally withdraws from a solvent borrower if other creditors also withdraw, often preceded by a circumstance in which each creditor extends further loans (and is willing to do so) if the other creditors do likewise
• Bubble collapse - investors purchase financial assets above their fundamental value in the expectation of future gain; the bubble eventually bursts and a crisis occurs
• Moral hazard crisis - banks overlend and, in the process, lend to risky ventures
• Disorderly workout - a grab race by creditors for an illiquid or currently insolvent borrower's assets, even though the borrower would be worth more as an ongoing enterprise. The problem here is essentially a lack of coordination among creditors

Back

Footnotes:

^a There are also political crises, for example, the Aquino assassination in the Philippines, current political turmoil in Indonesia etc., which have important impacts through economic channels, such as capital flight and reduced investment flows, but which are not included here.