What are the three types of financial crises identified in post-2008 research, and how do I tell them apart in real time?

Distinguishing the three crisis types is one of the most important practical skills in post-crisis CME because each type has very different implications for long-term portfolio positioning.

The Three Types:

Type 1: Persistent Level Drop, Unchanged Growth Rate

GDP drops suddenly during the crisis and does not return to the pre-crisis path. However, once the crisis ends, the economy resumes growing at approximately its pre-crisis trend rate — just from a lower starting point.

Signal characteristics:

• Quick recovery to stable growth (typically 2-4 years)
• No evidence of persistent labor market damage
• Financial system rebuilds without permanent capacity loss
• Underlying productive capacity intact

Historical analogue: Some emerging market banking crises have fit this pattern when aggressive recapitalization and stimulus policies restored normal dynamics quickly.

Type 2: No Level Drop, Reduced Growth Rate

Less common but possible. The economy does not suffer a sharp immediate drop but subsequently grows at a slower pace than before. The crisis leaves subtle structural damage that reduces future growth without causing immediate output loss.

Signal characteristics:

• Shallow or non-existent recession
• But post-crisis growth consistently below pre-crisis trend
• Often reflects regulatory or structural responses to the crisis
• Gap widens slowly over time

Type 3: Persistent Level Drop AND Reduced Growth Rate — THE EUROZONE CASE

The worst combination. GDP drops sharply AND the subsequent growth rate is permanently lower. The gap relative to the pre-crisis trajectory widens every year.

The eurozone exemplifies this pattern. The structural and policy factors that led to Type 3:

How to Diagnose the Type in Real Time:

Unfortunately, the curriculum emphasizes that exogenous shocks' effects on trend growth are not identifiable until they are "well-established and retrospectively revealed in the data." But several early signals can hint at the emerging type:

Signals pointing to Type 1 (level drop only):

• Rapid decline in unemployment after recession
• Strong rebound in private investment
• Quick credit market normalization
• No signs of structural damage to labor force or capital stock

Signals pointing to Type 3 (level + growth rate):

• Persistent long-term unemployment (labor hysteresis)
• Weak private investment recovery (capital hysteresis)
• Deleveraging drag from zombie institutions
• Structural impediments preventing reallocation
• Unified currency without unified policy response

Practical Example — Ashworth Capital 2011-2015:

Ashworth's CME analyst tracking the eurozone observed progressively darker signals:

• 2011: Recession ongoing, unemployment rising — Type unclear
• 2013: Growth resumed but below pre-crisis trend — possibly Type 2 or 3
• 2015: Persistent output gap AND slower trend growth — clearly Type 3

For the US, the same period showed:

• 2011: Recovery underway, growth below trend
• 2013: Growth continuing but output gap remaining
• 2015: Evidence of lower post-crisis trend growth, but less severe than EU

Both regions experienced Type 3 dynamics, but the US more mildly than the eurozone due to more flexible labor markets and a unified fiscal/monetary response.

CME Implications:

For a Type 3 crisis, CME adjustments should include:

• Lower long-term equity return expectations
• Lower long-term bond yields (reflecting lower nominal growth)
• Wider risk premiums during the extended adjustment
• Structural tilts away from the affected region

Test your crisis type analysis in our CFA Level III question bank.