Understanding the Relationship between Output Growth Expectations and Financial Crises

This paper explores two dimensions of the relationship between outputgrowth expectations and financial crises. The first dimension is the relationship between volatility of output growth expectations and the frequency of financial crises. I describe the conditions that are needed to explain the frequency of crises we observe in highly volatile economies, and I show how models with learning about output growth trends are able to generate those conditions. The second dimension is the relationship between volatility of output growth expectations and the severity of financial crises, measured by output losses. I report that more stability of expectations is associated with more severe debt and banking crises, consistent with the Minsky Financial Instability Hypothesis.

Keywords: Expectations, Volatility, Financial Crises