“A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region's economy to its knees.”
The Scandinavian banking crisis may be a good case for what can happen to the banking system and the currency when you have a twin crisis. Of course, the analogy may not be perfect but it is something that the Fed is looking at closely. An asset bubble associated with loose credit occurred in these countries, but there was also a corresponding shock. In the case of the United States, the shock may just be an old fashioned oil price rise. Unfortunately, we have seen this story before.
The important lesson from the Scandi crises is that there is no easy solution that will save the economy in th short-run. There was the need to nationalize some of the banking system, and the cost to the taxpayers was significant.
The Scandinavian Crises
Norway, Finland and Sweden experienced a classic boom-bust cycle that led to twin crises. In Norway, lending increased by 40 percent in 1985 and 1986. Asset prices soared while investment and consumption also increased significantly. The collapse in oil prices helped burst the bubble and caused the most severe banking crisis and recession since the war. In Finland an expansionary budget in 1987 resulted in massive credit expansion. Housing prices rose by a total of 68 percent in 1987 and 1988. In 1989, the central bank increased interest rates and imposed reserve requirements to moderate credit expansion. In 1990 and 1991, the economic situation was exacerbated by a fall in trade with the Soviet Union. Asset prices collapsed, banks had to be supported by the government and GDP shrank by 7 percent. In Sweden, a steady credit expansion through the late 1980s led to a property boom. In the fall of 1990, credit was tightened and interest rates rose. In 1991, a number of banks had severe difficulties because of lending based on inflated asset values. The government had to intervene and a severe recession followed.