The Critical Stage

Abstract

The standard model of the sequence of events that leads to financial crises is that a shock leads to an economic expansion that then morphs into an economic boom; euphoria develops and then there is a pause in the increase in asset prices. Distress is likely to follow as asset prices begin to decline. The pattern is biological in its regularity. A panic is likely and then a crash may follow. Lord Overstone, the leading British banker of the middle of the nineteenth century, saw a similar pattern and was quoted with approval by Walter Bagehot: ‘quiescence, improvement, confidence, prosperity, excitement, overtrading, CONVULSION [sic], pressure, stagnation, ending again in quiescence’.1 Overstone identified five stages of euphoria before the financial crisis, or, in his words, the convulsion.KeywordsInterest RateReal EstateAsset PriceMutual FundFederal ReserveThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.