Difference Between Financial Crisis and Economic Crisis

Main Difference – Financial Crisis vs Economic Crisis

Every country has its own economic challenges. A crisis is a downturn that often has negative impacts on the people who have a stake in the performance of an economy. Financial crisis and economic crisis are two economic terms which explain the adverse status of developing economies. Financial crisis mainly occurs due to drop of values of the financial assets; thus it influences the financial and investment markets in an economy. On the other hand, the economic crisis is the overall slump in the economy that has an influence on entire economic activities. This is the main difference between financial crisis and economic crisis.

This article explains,

1. What is a Financial Crisis? – Definition, Contributing Factors, Influences and Impact

2. What is an Economic Crisis? – Definition, Contributing Factors, Influences and Impact

3. What is the difference between Financial Crisis and Economic Crisis? 

What is a Financial Crisis

If the nominal values of the financial assets are falling rapidly in an economy, that situation is known simply as a financial crisis. A financial crisis is associated with one or more of the following facts.

• Significant changes in volumes of national credit and asset prices
• Disturbances in financial intermediary activities
• Severe balance sheet problems
• Large scale government support on liquidation and recapitalization

Financial crises are often led by asset and credit movements. If the asset prices in an economy bubbles and credit booms continue, the economy might become unsustainable and result in a financial crisis. Banks and other financial institutions are key determining parties for a financial crisis in a particular economy. A financial crisis may occur due to overvaluing the assets, and will be intensified by the investor behavior. Selling off the assets of these banks and financial institution rapidly will result in lower asset prices and more saving withdrawals. If these financial crisis factors remain in the economy over a significant time period, it will produce economic recession and depression in the long run.

What is Economic Crisis

Economic crisis can be defined as a sudden economic downturn caused by a financial crisis. The economy performs very poorly in these crisis periods; it is characterized by continuous falling in GDP (Gross Domestic Product) and rising price levels, poor production volumes that do not meet the demand, lower liquidity, higher rate of unemployment, lower investment and trade, etc. The following factors can contribute to an economic crisis.

• Unexpected decline of values of stocks and securities
• Frauds – mismanagement of funds at a huge scale
• Asset liability mismatch of financial institutions

An economic crisis has a severe impact on the general public. Increasing unemployment rate impacts the living conditions of the people whereas the downturn of the performance of financial institutes has a severe impact on the performance of the entire economy.

Similarities Between Financial Crisis and Economic Crisis

Both concepts are unfavorable for an economy and a financial crisis may create an economic crisis.

Difference Between Financial Crisis and Economic Crisis

Definition 

Financial Crisis: Financial crisis is the decline of the nominal value of financial assets.

Economic Crisis: Economic crisis is the downturn of the entire economy including business and household sectors.

Categorization 

Financial Crisis: Financial crisis can be classified into two:

a)  Currency and sudden stop crisis – speculative slump on value of currency, sharp depreciation of currency

b)  Debt and banking crisis – a situation where a nation cannot service its foreign debt

Economic Crisis: Economic crisis can be classified into five:

a)  Credit crisis – crisis happens in the financial sector

b)  Financial crisis – drop values of all the financial assets

c)  Fiscal crisis – incapability of the government to pay off debts

d)  Currency crisis – rapid drop in currency values

e)  Hyperinflation – severe amount of inflation

Interrelation 

Financial Crisis: Financial crisis is a market failure in the financial sector, if no corrective actions were taken, this will lead to economic crisis.

Economic Crisis: Economic crisis is a hazardous state of an economy at a given point of time.

Effect

Financial Crisis: Financial crisis directly affects the banking and financial sector.

Economic Crisis: Economic crisis directly affects the economic entities in the entire economy.

Financial Crisis vs Economic Crisis – Conclusion

Financial crisis and economic crisis are two concepts used in macroeconomics. Both terms represent adverse economic influences. Financing crisis is the economic downturn that occurs as a result of dropping values of the assets and other financial institutions in an economy in a drastic manner. Moreover, the economic crisis is the overall economic downturn that includes credit, financial, fiscal, currency crisis, and hyperinflation. When comparing the two concepts, we can see  an economic crisis has a severe and long-run impact on all the economic entities. Economic crisis gives a big picture of the overall economy whereas financial crisis can be identified as a sub-selection of economic crisis.

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