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Economic epidemiology

Predicting financial contagion

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Readers' comments



WT Economist

I'd call it the "elephants in the room" effect. Financial markets can get far out of line with reality, as relentless propaganda causes participants to ignore the elephants in the room. Then a dramatic event brings one elephant into view. Suddenly, the others are also noticed, or might be.

Public and private debts are out of line with the incomes that support them in many places. That has been true for some time. Having noticed Greece, the fear was that people would then notice Italy, Spain, etc. The fact that people feared these places would be noticed meant they had been noticed already, which led to fears that others would react to what had been noticed.

But the underlying issue was there all along. When contagion spreads to a place without such an issue, say Switzerland, then I'll see things differently.

jouris - old account

In short, contagion is herd behavior, based on an expectation of herd behavior. Investors, buyers and sellers expect that "similar" countries to exhibit similar problems and successes -- no matter how dissimilar their policies or circumstances are. And others feel impelled to do what "everybody else" is doing.


It seems probable that "pure" contagion takes place in people's minds.

Do Greek problems really affect Spain? Well, if I'm a bond investor, and I watch what just happened with Greece, I might be more reluctant to put money someplace "safer, but not quite safe" like Spain. I might perceive the risk of Spanish bonds as being higher than I did before Greece, even if the actual risk has not changed. And behold, contagion.


The dreaded contagion has already taken place, and all of the indebted Euro countries are more or less affected. It goes without saying that every additional shock will again reverberate throughout the Euro zone. A Greek bank run will undoubtedly encourage inhabitants of countries like Spain or Italy to move their money to safer places if they have not already done do. Rescue attempts no longer work: After receiving 100 billion Euro, Spain saw its bond interest rate rise even more.

More serious, however, is the fact that foreign money is also leaving the Euro. Pimco sold its last German Bonds, Ahmadinejat exchanged his Euro-denominated oil billions into US dollars, even Lloyds of London withdrew its funds from Paris banks. The list is no doubt endless.



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